Commission-based investment advice

Discussions about a ban on commission for investment advisory services have flared up time and time again. At the end of 2022, former EU Financial Markets Commissioner Mairead McGuinness again put commission-based investment advice under scrutiny. She complained that commission-based advice often leads to retail investors being sold expensive or unsuitable products. And the disclosure of costs for financial products regulated in MiFID II has not led to a shift from commission-based to fee-based advice.

In May 2023, Mairead McGuinness unveiled proposals for a directive to implement the EU retail investment strategy. Although they do not include a full ban on commission-based advice they contain ban in commissions in non-advisory sales. However, in spring of 2024, the EU Parliament and Council voted against any ban on commissions, including a partial one.

With a commission ban, even a partial one, the Commission would not achieve its goals and would harm retail investors. For example, a ban on commission in non-advisory sales would result in services provided by distributors, such as order execution, being priced separately. However, this would disproportionately burden savers with small investment amounts.

Nevertheless, the Commission assumes that a ban on commission would reduce product costs and thus increase investors' portfolio return. However, a BVI paper, which analyses public data from the European Central Bank and the UK’s Office for National Statistics, shows that this assumption is not correct: A ban on commission does not lead to higher returns for private investors and even prevents them from participating more in capital markets.

In the UK and the Netherlands, portfolio returns have not changed due to the ban introduced there about ten years ago. Obviously, other effects have compensated for the lower costs of commission-free products. For example, distribution costs are typically not reduced by a ban of commission, but only paid separately. In addition, an advisory gap could lead to private households participating less in capital markets, for example with funds. This would mean that they would miss out on return opportunities.

The BVI paper shows that private investors in the UK and in the Netherlands actually have been saving less in funds due to the ban. The BVI estimates the resulting decline at an average of nearly EUR 340 per capita per year. In the case of funds, bans – not commission-based advice – are what prevent private investors from participating more in capital markets. This contradicts everything the EU wants to achieve.

The proposals for a retail investor strategy also contain additional requirements for advice and new transparency obligations, especially regarding costs. But these measures harm savers as well. They focus unilaterally on costs. This is demonstrated by the new best-interest test, which is supposed to ensure that financial advisors act in the best interest of their clients. It is primarily focused on costs, with the added value of a product for the client no longer playing a role.

The considerations of the EU authority ESMA for a value-for-money test, which is intended to ensure that financial products offer investors adequate value for their costs, also primarily focus on costs alongside historical performance. A BVI paper criticises that the ESMA proposal for the value-for-money test would mislead retail investors. Additionally, the one-sided fixation on costs comes at the expense of product quality and innovation. For savers, the expected return and the quality of a product are just as important as the fees.

In summary, the EU retail investor strategy does not achieve any key political objective – neither attracting retail investors to the capital markets nor enhancing investor protection. What remains is only additional bureaucracy for providers, regulators, and customers. Everyone talks about reducing bureaucracy; it would be best to abandon this project.