Retail Investment Strategy (RIS)

The European Commission published its Retail Investment Strategy (RIS) on May 24, 2023, with the purpose of enabling retail investors to make better-informed investment choices that are in line with their requirements and financial objectives. Concerns over the comparatively low degree of retail engagement in capital markets inside the EU as compared to other mature nations served as the impetus for this legislation package.

The Commission emphasised that in 2021, just around 17% of household assets in the EU were invested in financial instruments such as derivatives, bonds, shares, and mutual funds. The low participation rate can be attributed to various factors such as product suppliers who may gain from commissions, inertia, and lack financial knowledge. The Commission also acknowledged the importance of new developments like digitization, which makes it simpler to acquire services like inexpensive automated sales, and the increasing interest in sustainability among retail investors.

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RIS restoring consumer trust by shrinking the investment universe

RIS restoring consumer trust by shrinking the investment universe

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Retail Investment: EU Reform Framework

The EU’s reform of retail investment faces mixed reviews. The financial sector supports digital-first communication and financial literacy efforts, but also raises concerns about commission bans, complex consumer rules, dubious benchmarks, and an unrealistic implementation timeline.

GrandAlessandro Micagni

European Commission's Retail Investment Strategy (RIS): Encouraging Retail Investors

The European Commission has launched the Retail Investment Strategy (RIS) with the objective of enhancing the confidence and decision-making abilities of retail investors in the capital markets. This legislative package aims to modernize current legislation and address a number of issues impeding retail involvement in investing activities, It consists of a proposed Regulation and a Directive:

• Extent of Amendments: The Omnibus Directive included in the RIS amends the major directives, including Solvency II, AIFMD, UCITS, IDD, and MiFID II, as well as the regulatory frameworks they establish.

• Political Process: On October 5, 2023, European Parliament rapporteur Stéphanie Yon-Courtin released her draft reports on the RIS. However, there may be delays in adopting the final RIS wording due to the upcoming June 2024 European Parliament elections.

• Impact on MiFID II: The main topic of this briefing is how the Omnibus Directive affects MiFID II; it does not address changes to AIFMD, the UCITS Directive, IDD, or Solvency II.

• Measures Anticipated: The Commission's goals with the RIS include updating disclosure regulations to reflect investors' preferences for sustainability and digital innovations, setting benchmarks for assessing the value of financial products, outlawing inducements for "execution-only" sales, bolstering oversight of financial advisors, guaranteeing transparent and equitable marketing practices, improving advisors' and retail investors' understanding of the financial markets, and enhancing investor categorization and supervisory cooperation between Member States and European supervisory authorities.

By taking these steps, the RIS hopes to promote an investment environment that is more open, fair, and knowledgeable and that encourages the involvement and protection of retail investors.

Disclosure Rules in the European Commission's Retail Investment Strategy

The three main areas that the European Commission is working to modernize the Retail Investment Strategy (RIS) disclosure standards are risk warnings, marketing communications, and dealing with unwanted access through digital means.

• Risk Warnings: Contracts for differences (CFDs) are required by law to carry risk warnings, including on social networking sites. Nevertheless, comparable warnings for other high-risk financial goods or services are lacking at the EU level. The objective of the Omnibus Directive, as delineated in Article 24 of MiFID II, is to mitigate this disparity by requiring investment firms to incorporate pertinent risk advisories in all educational materials pertaining to exceptionally hazardous financial instruments.

• Within eighteen months of the Omnibus Directive's adoption, the European Securities and Markets Authority (ESMA) would define "particularly risky financial products" through the development of guidelines and technical standards. When the lack of risk warnings could seriously jeopardize investor protection, ESMA has the authority to implement them and may even confer with NCAs in this regard. Proposed changes support expanding the use of risk warnings beyond products that are particularly dangerous, acknowledging that they are necessary in a variety of situations. Rules permitting NCAs to use webscraping software to monitor online communication platforms are also included in the suggestions.

• Marketing Communications: Significant changes to the marketing communication laws under MiFID II are brought about by the Omnibus Directive. It requires investment businesses to clearly identify marketing materials and provide key product attributes in their communications, ensuring accountability and openness. These messages ought to be impartial, well-rounded, and properly directed towards investors.

• The directive also establishes standards for companies to monitor marketing techniques, imposes yearly compliance reports, expands record-keeping obligations, and defines roles and responsibilities for manufacturers and distributors. The changes also include ways to control social media influencers and solve issues with digital outlets. The overall goals of these modifications are to improve investor protection and transparency in a changing financial environment.

• Unauthorised activities: The European Commission is aware of the risks that digitalization presents to individual investors, including the possibility of illicit investment services or activities being made available online. In response, the Commission is adding new obligations to MiFID II under Article 5a, which addresses these illegal actions. This entails creating a new ESMA database that records the actions taken by National Competent Authorities (NCAs) against organizations providing unapproved investment services or activities, as well as updating the authority specified in Article 69(2) of MiFID II.

Handling Conflicts: Recognizing Shifts in Motives and Interest Conflicts

The European Commission has made significant modifications to the MiFID II regulations in order to address concerns around conflicts of interest and inducements in retail investment. Retail investors face an additional hurdle of not always receiving the best deals due to the current state of the economy. Incentives are now permitted under MiFID II, mostly through a commission-based distribution mechanism, which creates inherent conflicts of interest. In order to address these problems, the Omnibus Directive proposes measures such as exclusions from certain inducements and clarifications of exemptions.

The rapporteur for the European Parliament recommends changes to the review clause and more openness as an alternative to a complete prohibition on inducements. Furthermore, a "best interest" test will take the role of MiFID II's quality enhancement test, requiring financial advisors to base recommendations on a variety of appropriate products and provide affordable solutions. The Directive also requires a three-year evaluation of the impact of third-party payments on retail investors.

Product Governance: The Role of Benchmarks in MiFID II

The goal of MiFID II's product governance rules is to guarantee that financial products serve the best interests of clients. These regulations are strengthened and pricing procedures are regulated, especially with regard to benchmarks, by the Omnibus Directive. Products must not diverge from standards unless there is a valid reason, according to a new Article 16a MiFID II. ESMA is responsible for creating cost and performance benchmarks. Although the Commission expects the costs of IT system adjustments to be small, there are worries about possible disruptions to the market and unclear benchmark techniques. Despite the fact that the rapporteur removed benchmarks because of these worries, a press statement from the European Parliament recommends keeping them in place for supervision purposes only—without regulating prices.

Key Changes in the Omnibus Directive for Investor Protection

With regard to suitability and appropriateness tests, requirements for investment advisors, client categorization thresholds, financial literacy promotion, and supervisory enforcement, the Omnibus Directive significantly modifies the investor protection provisions under MiFID II.

Key Changes:

• Suitability and Appropriateness Tests: Investment firms are required by the Directive to gather all pertinent information required for assessments and to explain to retail investors the aim of the assessments. Investors will be informed of the repercussions of erroneous information through standardized alerts. Furthermore, independent advisors are only able to provide guidance on a small selection of cost-effective, diversified, and simple financial products.

• Investment Advisors: New regulations reinforce and harmonize the knowledge and proficiency standards for advisors in investments. A new MiFID II annex will house some requirements, and certificates and continuous professional development will be used to confirm compliance.

• Thresholds for Client Categorization: A new criterion pertaining to education or training has been added to the eligibility requirements for professional investors, which lowers the financial threshold. Legal entities that satisfy certain financial requirements may also be considered professional clients.

• Financial Literacy: The Directive encourages financial education initiatives at the Member State level to enable retail investors to make responsible investments, acknowledging the low levels of financial literacy among consumers.

• Supervisory Enforcement: Cross-border supervisory enforcement is strengthened by measures such as investment firms reporting on cross-border activities and the creation of platforms for collaboration between European Supervisory Authorities and National Competent Authorities (NCAs). The proposed revisions require corporations to register in the same Member State as their head office, in an effort to discourage forum-shopping.

The Future of the Retail Investment Strategy

There are questions around the approval of the Retail Investment Strategy (RIS) by the EU Council and the Parliament as the European Parliament gets ready for the elections scheduled for June 2024. The suggested modifications would cost investment businesses more even though their goal is to increase investor protection and trust. Concerns are raised by the possible reduction in the investment universe, especially with relation to execution-only business. Though there are unknowns, a properly executed RIS has the potential to restore confidence between investment firms and their clients, providing optimism for successful results after a prolonged summer vacation.