Talking point
MiFID 2: Investment advice in Europe to be redefined

November 4, 2011

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40% of all household wealth in the eurozone is held as financial assets in the form of deposits and investment products – around EUR 19 trillion. A European Commission proposal for a directive (“MiFID2”) will change this market: in future banks are to inform consumers whether the advice they offer is independent or restricted. If the advice is independent, charging commission is to be banned. The paying of commission is, however, in most member states the standard model of remuneration for the investment advice provided by banks. Irrespective of this practical aspect there is the question of whether the “independent” label will promise the consumer more than the individual advisor is capable of delivering.

61% of investors get advice before making an investment, as found by a recently published Fidelity survey conducted in 14 EU countries. Most investors (68%) turn to their bank for this advice. As surveys confirm, many investors presume that their investment advisors not only act in the interests of their clients, but that they also recommend certain products out of self-interest. This presumption is a result not least of the way in which advisory fees are usually depicted, that is mostly as percentage amounts in product information documents and contracts. The latent dissatisfaction about this does not, however, lead the overwhelming majority of investors to the conclusion of searching out a fee-charging investment advisor instead of a traditional bank advisor. A fee-charging investment advisor offers advice only, but does not sell any products. On the contrary, just 7% of investors say that they would definitely be prepared to pay directly for advice. 37% can at least imagine doing so. At present only 9% of investors consult an independent advisor.

What is the sticking point with commission-based remuneration?

The remuneration of investment advisors in banks usually consists of several components: the client incurs one-off costs (e.g. subscription fees) and recurring costs (e.g. management fees); in addition the advisor receives a so-called “kick-back” payment from the product maker for his marketing service that may also come from the subscription fee paid by the client. On top of this there may be additional bonuses or the like that are paid by the investment advisor’s employer depending on the products and the quantity sold by the advisor. The investor is aware of the direct fees he pays, but as a rule is not aware of the scale of other remuneration streams. The Verbraucherzentrale Bundesverband (vzbv) – the German consumers’ association – recently discovered that banks refused to supply information about these indirect fees in roughly 46% of cases. Although the survey was not representative, it does become clear that there is some ground to be made up with regard to transparency. The problem is that without supplementary control measures and incentives the commission-based remuneration model can result in an advisor tending to recommend products that bring the advisor a high commission rather than a product that yields a lower commission which might be more suitable for the given client. Such supplementary control mechanisms and incentives can, for example, consist of a portion of the advisor’s remuneration being made dependent on metrics that measure the long-term benefit to the customer, such as customer satisfaction surveys or medium-term performance of the portfolio.

Different remuneration – different conflicts of interest

A conflict of interest comparable to that with commission-based remuneration does not exist with fee-based advice – there are other conflicts of interest, however: where the fees are charged by the hour, for example, it could be in the interests of the advisor to take more time. Where the remuneration is based on the size of the portfolio it could be in the advisor’s interest to spend more time on larger portfolios than smaller ones. Essentially, a fee-based system generates incentives to advise richer clients for longer and/or to only advise rich clients.

In short, while a commission-based system can result in the client not receiving the correct advice a fee-based system can result in advice not even being offered in the first place.

One part of the solution: Performance-based remuneration

In both models there would be no payment-induced conflict of interest if the remuneration were to be substantially performance based, i.e. the advisor were to receive a share of the earnings on the investment spread over the period that the investment is held. Since the advisor has certain fixed costs a wholly performance-based remuneration system does not, however, appear recommendable. Solely performance-based remuneration could lead to the advisor having an incentive to recommend higher-risk (and thus usually higher-yielding) investments. This underlines the necessity when evaluating how remuneration models are actually used of not looking at them in isolation, but of assessing how they fit into the overall incentive, control and remuneration systems of a financial services provider.

Differing regulatory speed and content

The dissatisfaction of many investors influenced by the financial crisis in many countries has triggered a public debate – despite the fact that the dissatisfaction is evidently not felt so keenly that customers therefore actively alter their demand for advisory services. In the UK the debate about the topic has already resulted in the banning of commission payments between “product makers” and advisors from 2013 onwards. In future an advisor in the UK will only be able to be remunerated by the investor. This measure is intended to prevent the conflict of interest that results from the payment of commission.

In Germany, too, the thinking is along these lines: the Federal Ministry for Food, Agriculture and Consumer Protection (BMELV) has already published “key elements” for a regulation covering fee-based advice. The objective in Germany is also that only the client should pay the advisor in future. With regard to commission there are no plans for a complete ban, but rather for a “passing-on of commission”. Two options are being considered for this: either the product vendor provides information about net costs in addition to the “intermediary costs” or advisors are obliged to pass on such commission to their clients. The latter option is likely to be the less draconian and at the same time an efficient method.

The European Commission has also made suggestions concerning the remuneration of advisors in its revised Directive on markets in financial instruments (“MiFID 2”).This means that only the advisors who do not accept commission from third parties can call themselves independent advisors. At the same time the independent advisor must assess a “sufficiently large number of financial instruments available on the market“. The ban on accepting remuneration from third parties would also apply to portfolio managers. The Commission has thus chosen a more restrictive solution than that which has been considered by the BMELV to date.

Also, when cross-selling takes place the investor must be informed whether the combination of products that have been sold to him can also be bought separately. The investor must also be provided with itemised information of the costs of each individual product.


The categorisation as “independent” and “tied” could become problematic when considering consumers associations and expectations with those terms. “Independent advice” sounds good in the beginning. There are, however, no stipulations – statutory or otherwise – that independent advice must also be of a better quality.

High-quality advice is largely the product of two factors:

1. Whether during the consultation the client’s investment objectives, financial circumstances and risk appetite are taken properly into account and

2. Whether the client has certain basic knowledge about financial instruments that enables him to judge whether the advisor has actually done that properly.

Whether an independent advisor gives better advice than a tied advisor has not hitherto been empirically investigated to a sufficient degree. The elimination of one conflict of interest (provision of bad advice for monetary motives) will possibly be merely replaced by a different one (poor advice or none at all). For the client it is ultimately irrelevant whether the reason he does not receive good advice is because his advisor has a remuneration incentive from a third party or because the advisor does not spend enough time with him (or does not even give him advice in the first place). A one-sided fixation on remuneration-driven conflicts of interest will therefore not provide consumers with better investment advice. To gain a comprehensive picture other incentives and control mechanisms and the major differences within the group of consumers must also be taken into account. There are very big differences between consumers’ basic knowledge of financial products. Measuring the overall quality of investment advice is difficult – the BMELV has commissioned a corresponding report which is due to be published soon. 

The prospective European legislation will lead to considerable changes in the business models of banks and financial product makers as regards the marketing of investment products and provision of advice about such products. When formulating new rules the political decision-makers should ensure that one conflict of interest is not simply replaced by a different one. Possible areas to be focused on are:

1. Requirements concerning the type of remuneration (for all advisors!), i.e. more performance-related remuneration. In so doing the riskiness of the asset must not be ignored. Performance would have to be measured using a risk-adjusted indicator.

2. Demands to be made of member states to include financial education as a more prominent element of school education, training and further education.

For investors little will change for the time being – it will definitely take more than two years for MiFID 2 to complete the European legislative process and be transposed into national law. The announcement on its own could, however, prompt banks to comply in advance with individual regulations that they anticipate will be introduced.


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