Shaped by the Rules. How Inducement Regulation Will Change the Investment Service Industry

1. Introduction

With the exception of the Netherlands, the business model of European distributors is mostly based upon ‘inducements’:^[1] commissions, fees and other non-monetary benefits typically paid back to financial intermediaries by asset managers for the distribution of their products.

Such a remuneration scheme may create a severe conflict of interests between distributors and their clients. For this reason, MiFID II and its implementing legislation tightened the requirements for the collection of inducements, aiming at filling the fallacies showed by the former regulation.

Although conflicts of interests are the main target of inducement regulation, this new set of rules will also indirectly change the very business model of European distributors. Indeed, it is very likely that distributors will have to shift their organization either towards fee-only independent advice (as the Netherlands have already did) or amend the contents and the features of their ‘traditional’ investment services in order to make them compliant with the new MiFID II provisions. Of course, the stricter these rules are, the more ‘disruptive’ such a change is going to be.

In accordance with these premises, this article intends to examine how – and to what extent – inducement regulation is going to shape the European distribution systems of investment products, assessing also whether the new rules are able to adequately protect retail investors in the recent technological and ‘cultural’ evolution of financial markets (sections 2–4). From this new perspective, the article will analyze the overarching architecture of MiFID II investment services, discussing in more detail the role of the new inducement regulation in modeling the provision investment advice (sections 5–9). Nonetheless – since MiFID II permits the collection of inducements only when they are able to enhance the quality of the investment services offered by the distributor – this new regime will probably increase the overall costs of investment advice, thus enlarging the so-called ‘advice gap’ (section 10). Because FinTech – and especially robo-advice – may represent only a partial solution, section 11 will attempt to solve this problem, while section 12 will conclude.

2. Beyond Conflicts of Interests: Inducement Regulation as a ‘Public Policy Device’

As already mentioned, the broad diffusion of inducements raises serious concerns about investors’ protection. Indeed, since competition among investment products depends mostly on the selection of the proper distribution channel, issuers could intensify efforts and allocate resources to strengthen their relationships with investment firms rather than improve the quality of their products. On the other hand, distributors – looking for a more favorable remuneration – may neglect clients’ best interests and product suitability. Such practices could result in low-quality investment products, biased advice, poor asset allocation and eventually mis-selling.^[2]

For these reasons, the European regulator traditionally looks at inducements as a harmful source of conflict of interests,^[3] imposing on distributors both organizational requirements and conduct of business rules.^[4] Every investment firm, indeed, must “take all appropriate steps to identify and to prevent or manage conflict of interests ... caused by the receipt of inducements”.^[5] Furthermore, the illicit collection of inducements is deemed to be a per se violation of the general duty to “act honestly, fairly and professionally in accordance with the best interest of the client” (art. 24, para. 9, MiFID II).^[6]

With the same purpose – considering the deep inconsistency between these investment services and the rebate of commissions – art. 24, para. 7 and 8, MiFID II radically bans the collection of inducements (except for minor non-monetary benefits) associated with the provision of independent advice and portfolio management.^[7]

2.1 Although correct, this interpretation fails to capture the ‘other side’ of inducement regulation: namely, the role it can actually play in shaping the distribution system of retail investment products.

As a matter of fact, the profitability of European distributors relies mostly on the commissions paid back by issuers and asset managers. Therefore, the regulation of inducements and, in particular, the ‘free spaces’ granted to them by art. 24 MiFID II (= the conditions under which inducements can be lawfully collected) are intended to have a substantial impact on the provision of investment services by financial intermediaries. Indeed, distributors cannot rashly renounce to collect inducements, and so they will have to ‘adjust’ their business model in order to make it compliant with MiFID II provisions.^[8] Hence, by selecting the criteria for the licit collection of inducements, the European regulator is also shaping the features and the contents of investment service provision, aiming at indirectly steering distributors towards investors’ protection.

From this perspective, European inducement regulation not only represents a solution to a conflict of interest problem; but it also acts as a ‘public policy device’ meant to conform the conduct of distributors towards a specific paradigm, in order to preserve market trust and prevent the negative externalities stemming from the breach of the fiduciary relationship that bounds every advisor with its clients.^[9]

2.2. Art. 24, para. 9, of MiFID II distinctly shows both of the above-mentioned functions laying down the requirements inducements have to comply with. On the one hand, it prescribes that all the inducements collected must “not impair compliance with the investment firm’s duty to act honestly, fairly and professionally in accordance with the best interest of its clients” (let. b) – redundantly evoking the close link between inducements and conflict of interest regulation. Yet, at the same time, it adds that inducement schemes must also be “designed to enhance the quality” of the service provided to the client (let. a).

This latter disposition clearly goes beyond pure a conflict of interest dynamic. Theoretically, once an inducement is proved not to impair the best interest of the client, nothing more should be demanded from the distributor.^[10] Nevertheless, the ‘quality-enhancement’ requirement of art. 24, para. 9, let. a, MiFID II ‘selects’ also some specific features of investment services considered by the European regulator more suitable to protect investors’ confidence and capital markets soundness, allowing the collection of inducements only under those specific circumstances. By doing so, financial intermediaries are ‘nudged’ to provide investment services compliant with those features (otherwise they cannot be remunerated for the services they provide).

3. MiFID II Inducement Regulation

Such a ‘quality-enhancement’ requirement is further specified by art. 11, para. 2, of the Commission Delegated Directive (EU) 2017/593 (‘Delegated Directive’), which distinguishes between investment advice and the other – merely executive – investment services.

In particular, as to investment advice, the distributor shall guarantee either: (a) “access to a wide range of suitable financial instruments including an appropriate number of instruments from third party product providers having no close links with the investment firm” (‘quasi-independent advice’);^[11] or (b) a periodic assessment – “at least on an annual basis” – of “the continuing suitability of the financial instruments in which the client has invested”, rather than periodic “advice about the suggested optimal asset allocation” (‘periodic advice’).^[12]

Instead, with reference to the provision of the other merely executive investment services, distributors can receive inducements only if they grant the access, (i) “at a competitive price”, (ii) “to a wide range of financial instruments”, together with (iii) “the provision of added-value tools” or other “periodic reports” that can help clients “to take investment decisions” and “to monitor, model and adjust the range of financial instruments” in which they have invested.^[13]

Moreover, in assessing adherence to the requirements listed above, distributors should explicitly take into account whether all the commissions payed by the client are “proportional” to the quality of the investment service actually provided,^[14] and whether the investment service offered entails a concrete and “tangible benefit” to him.^[15] In other words, this assessment should not be exclusively theoretical, but the financial intermediary must prove that the specific investment service offered is fully coherent with the actual best interest of the client. From this point of view, the mere provision of a ‘quality-enhanced’ investment service is not sufficient to justify the collection of inducements; rather, the distributor also has to judge whether the offered high-quality features of the investment service actually grant a “tangible benefit” to the client.^[16]

4. The Changing Market for Investment Services: The Rise of FinTech and the Role of Financial Advisors

According to the ‘public-policy function’ of inducement regulation, the list of conditions laid down by the Delegated Directive tries to mirror very closely the recent evolution of financial intermediation.

4.1 Thanks to the astonishing development of technology applied to financial activities (‘FinTech’), algorithms and other forms of robo-advice can now provide investors with a diversified investment portfolio, widely coherent with their personal characteristics and needs.^[17] Naturally – despite the new findings of behavioral economics^[18] and the most recent recommendation of ESMA^[19] – FinTech advisors allow only a mere ‘self-assessment’ of the investor’s profile.^[20] Therefore, the portfolio identified by the robo-advisor seems to actually represent “a more logical choice” of the investor, rather than a real “third-party recommendation”.^[21] Moreover, investment allocation may result in one-time advice, seldom updated or improved with respect to both financial markets evolution and – especially – client’s changing characteristics.^[22]

Yet, FinTech services may be extremely cheap if compared to ‘traditional’ investment advice and could thus represent a competitive alternative for smaller investors who cannot conveniently afford the costs of the traditional distribution channels.^[23] Hence, the wide support showed by regulators to “the development of mass-market automated advice models that have the potential to bridge the advice gap” that is excluding many retail investors from the market.^[24]

4.2 In such a scenario, the provision of simple one-time investment advice (the so-called ‘spot advice’) can hardly be justified to be in the actual best interest of the client. Indeed, this kind of investment service is to some extent comparable to FinTech advice, but much more expensive and limited to a narrower selection of investment products; rather, it seems to represent a pure rent-seeking that comes with the well-established position of the distributor.^[25]

From this point of view, spot advice can no longer be deemed to enhance the quality of the service offered by the distributor, and therefore inducements cannot be lawfully collected for the provision of such an advice. This conclusion is probably one of the most remarkable innovations brought by MiFID II, whereas the former discipline explicitly stated that every time an “investment firm provides investment advice or general recommendations”, then such advice “should be considered as having met the condition of being designed to enhance the quality of the service”.^[26]

Against this conclusion it cannot be argued that market dynamics are supposed to expel by themselves such practices, if really detrimental to investors. The lack of adequate transparency on the overall costs, the usually vague and fading contents of the services offered, as well as the difficulties traditionally experienced by retail investors in appraising the quality of the advice received, all tend to make competition among distributors less effective.^[27]

4.3 On the other hand, it is now fully acknowledged the role that professional advisors can play not only in the early assessment of clients’ profile or in the starting selection of investment products, but also (and, perhaps, mostly) in the on-going management of the portfolio.^[28] Indeed, even a suitable investment may easily turn into a severe loss if not properly monitored, and investors may also suffer from the missed opportunity of making additional earnings on their investments by promptly selling their assets. Hence, it is convenient to periodically monitor the portfolio optimal asset allocation, which may lead to realize revenues at the appropriate time and to efficiently govern market volatility (as well as investors’ anxieties).^[29] In addition, even the changing characteristics and needs of the client may demand a periodic update of the investment portfolio, in order to keep it fully compliant with the ‘suitability test’ required by art. 25, para. 2, MiFID II.^[30]

Most importantly, financial advisors can also play a crucial role in protecting consumers and preserving financial stability, providing households with ‘integrated’ financial assistance that may involve – besides investment advice – a proper debt reduction pattern, an adequate insurance plan, as well as private pension and retirement arrangements.^[31]

5. The Architecture of MiFID II Investment Services: The Perspective of Inducement Regulation

The new inducement regulation brought by MiFID II widely reflects all of these new market features.

First of all – as noted by the European Commission^[32] – FinTech may effectively address the advice gap experienced by smaller investors. Because of this, the Delegated Directive allows the collection of inducements even outside the provision of investment advice (consistently with the business model of many FinTech firms).^[33] At the same time, ‘spot advice’ – which poorly performed in the past – is indirectly banned by the quality-enhancement provision set forth in art. 24 MiFID II.^[34] Lastly, the acknowledged importance of on-going monitoring clearly opens up the collection of inducements linked to the provision of ‘periodic advice’.^[35]

Additionally, in line with the traditional function of inducement regulation, MiFID II also addresses the problems stemming from the conflict of interests between investment firms and their clients introducing – besides the general duty not to act against client’s best interest – independent and ‘quasi-independent’ advice.^[36]

6. Fee-Only Independent Advice

To this latter end, independent investment advice is certainly meant by the EU regulator to perform an essential role in financial intermediation, “not least given the higher levels of trust and the consequent potential for stronger market engagement associated with fee-based advice”.^[37] Indeed, the radical ban of inducements and the assessment of a wide range of third-party financial instruments are supposed to remove the major source of conflict of interests that may stem from commission-based advice provided by a single or multi-tied agent (and, a fortiori, from the placement of proprietary products).

Undoubtedly, the provision of independent advice removes the risk that both issuers’ activities and distributors’ assessments may be biased by the collection of commissions. However, a fee-only compensation scheme may give rise to new sources for conflicts of interest between investment firms and their clients.^[38] Since competition among independent advisors will mostly depend on their relative performances (id est: on the revenues actually earned by their clients), they may be incentivized to ‘waive’ or ‘stress’ the suitability requirements in order to carry out riskier activities and thus foster – at least in the short term – the expected gains demanded by the investors.^[39]

6.1 Anyway, the European market is not yet mature enough for fee-only independent advice. The current commission-based system is inherently opaque and most investors lack sufficient awareness about the costs of the service received: a significative number of clients, indeed, do not know how their advisors are compensated and some of them even believe investment advice is free, thus reducing their willingness to pay for such a service.^[40] Clearly, this kind of prejudice and misrepresentations greatly hinders the spread of independent advice, since an investment firm would have to move ‘against the market’ in the attempt to set a new standard.^[41]

With the purpose to overcome such biases, MiFID II conveniently strengthens the disclosure requirements over the features and costs of the investment advice provided by the investment firms.^[42] In particular, art. 11, para. 5, of the Delegated Directive and art. 50, para. 2, of the Commission Delegated Regulation (EU) 2017/565 (‘Delegated Regulation’) state that investment firms must aggregate and disclose – both on an ex ante and ex post basis – all the costs and charges directly or indirectly associated with the provision of an investment service. In addition, in order to increase investors’ awareness and to promote competition among advisors, all the inducements received “shall be itemized separately and the aggregated costs and charges shall be totaled and expressed both as a cash amount and as a percentage”.^[43]

The efficacy of such measures will be carefully assessed in the near future.^[44] Notwithstanding its obvious potential, the ability of this new transparency regulation in shaping the European financial intermediation system depends also on the investors’ capacity – still widely challenged – to appraise contents and features of the advice received.^[45]

7. The ‘Quasi-Independent Advice’ and the ‘Open-Architecture’ Requirement

In order to work around the difficulties of shifting to a fee-only intermediation system, the EU regulator has also introduced a ‘quasi-independent’ investment advice.

As pointed out by art. 11, para. 2, let. a, n. i, of the Delegated Directive, investment firms can receive inducements if they supply clients with access “to a wide range of suitable financial instruments including an appropriate number of instruments from third party product providers having no close links with the investment firm”. The possibility to invest in many financial products is an expensive solution for advisors, since they have to commit time, resources and effort to acquire information and monitor all the investment products distributed;^[46] in this respect, such a waiver of the inducement ban seems to be well grounded. At the same time – although the collection of inducement becomes licit – the independence of the advisor is still preserved by the variety of the ‘sources’ from which commissions can actually come. Moreover, the provision of a wide range of suitable financial instruments may broaden the investment choices available to clients, support portfolio diversification, and encourage the development of a more integrated European capital market.

7.1 Even though quasi-independent advice seems to embody the genuine rationale that inspired MiFID II regulation on investment services, it may be questioned whether it could actually represent an effective alternative for the European financial system.

Product governance requirements, indeed, greatly increase the coordination costs between manufacturers and their distributors.^[47] These latter have to “take all reasonable steps” to obtain “from the manufacturer” the information needed “to gain the necessary understanding and knowledge of the products” they sell.^[48] Above all, distributors also have to fix and adjust their distribution strategies in order to make them compliant with the target market pre-identified by the manufacturer, assuring that all the products they offer “are compatible with the needs, characteristics, and objectives” of their clients.^[49] In addition, they must periodically assess “whether the product or service remains consistent” with the relevant target market and “whether the intended distribution strategy remains appropriate”, promptly amending it when needed.^[50] All these costs critically affect procedures and organization of the investment firms, threatening to restrain their activity.^[51] For this very reason – since the EU financial markets are firmly controlled by distributors^[52] – such an increase in coordination costs will lead intermediaries to ‘close’ their architectures by selling, for the most part, products issued by firms belonging to the same financial conglomerate (who will ex ante design products fully compliant with the distribution policy of the whole group).^[53] Indeed, in a ‘distribution-oriented’ system, product regulation may create a ‘monopolistic relationship’ between manufacturers and their distributors, where the latter may demand the design of ‘tailor made’ investment products.^[54]

From this perspective, because of the ‘open architecture’ implicitly required by art. 11, para. 2, let. a, n. i, of the Delegated Directive, quasi-independent advice – in a market controlled by distributors – seems to represent an inefficient alternative doomed to remain a dead letter.

8. The New Market for Investment Services: Between FinTech...

Contingent on the results of the new transparency regulation (art. 24, para. 4, MiFID II), the provision of investment services will probably develop, at least in the near future, within two opposites ‘poles’: FinTech and periodic advice.^[55]

8.1 As already mentioned, the provision of mere ‘spot advice’ is de facto banned by the Delegated Directive.^[56] No longer profitable for distributors, who cannot receive inducements, the corresponding demand for investments advice will be probably taken up by FinTech firms, as they are able to offer a comparable service at a significantly lower cost.

Accordingly, the Delegated Directive allows the collection of inducements even outside the strict provision of investment advice,^[57] so as to encourage the development of FinTech services, while simultaneously reducing the risks associated with such an activity (once again, highlighting the ‘public policy’ function performed by inducement regulation). In particular, as in the case of ‘quasi-independent advice’,^[58] distributors shall provide clients with access to a wide range of third-party financial products, thus widening investment choices and preventing conflicts of interest. Indeed, thanks to the lighter approach involved in the provision of merely executive investment services, investment firms can distribute third-party products in an easier (and more profitable) way to their clients.

At the same time – closely restating the general incipit of art. 11, para. 2, let. a, of the Delegated Directive^[59] – all the investment products shall be offered at a “competitive price”. By imposing a strict proportionality between the service received and the commissions paid by the investors, MiFID II attempts to mitigate the risk that investment firms could unfairly benefit from the privileges that may come with their market position (rent-seeking).^[60]

Finally, distributors shall also provide “added-value tools” or other “periodic reports” that help clients “to take investment decisions” and “to monitor, model and adjust the range of financial instruments” in which they have invested. In this respect, because clients are not aided by their advisor in the ongoing management of the investments made (as in the case of spot advice), the EU regulator – maybe a little naively^[61] – tries to provide all the necessary tools to enable them to manage their own portfolio independently.

8.2 Having said that, some FinTech start-ups seem to prefer a fee-only business model, based on high-tech robo-advice, often shaped like a ‘standardized portfolio management’ and mainly focused on ETFs and other passive funds. Indeed, such investment funds – which have far lower management costs but still notable returns – may be, for these very reasons, unwilling to agree upon any inducement compensation scheme. Instead, this provision of the Delegated Directive could represent an effective alternative for FinTech services offered by incumbent distributors (especially by banks), which already have strong relationships with the major asset managers.^[62]

8.3 Lastly, it may be worth noting that in this new high-tech environment product governance could represent an effective protection for investors. Indeed, by regulating the ‘manufacturing process’, product governance distinctly signals the target market for which every investment product is designed,^[63] standardizing the possible outcomes of investment decisions and – to a certain extent – the distribution policy itself. At the same time, by requiring that “the strategy for distribution of the financial instruments is compatible with the identified target market”, product governance tries to prevent (at least) the most striking cases of mis-selling even in a fully-automated advising process, where the traditional suitability test seems to represent an incomplete solution.^[64] From this point of view, product governance finds its own natural environment in the FinTech industry rather than in the traditional intermediation channel, dominated by large banks and regulated by conduct of business rules.^[65]

9. ...And ‘Periodic Advice’ (Follows)

On the other hand, traditional investment advice will probably shift towards ‘periodic advice’, the only effective alternative left by the Delegated Directive in order to keep collecting inducements.

In this regard, it is important to understand that, from a public-policy perspective, periodic advice is better able to meet the aforesaid need that investors be ‘guided’ all along their investment relationship with the distributor. Indeed – by monitoring over time the suitability of the client’s portfolio, as well as the abidance of a correct asset allocation – periodic advice can effectively encompass (in a sense) even the on-going management of the investments carried out.

Not surprisingly – in line with this reasoning – MiFID II explicitly enlarges the definition of investment advice to encompass all trading recommendations, “including whether or not to buy, hold or sell an investment”.^[66] This provision clearly represents a valuable protection for investors, even though – at least in the provision of periodic advice – it could involve more severe liability for the investment firm.

From this perspective, periodic advice seems to resemble a rudimentary form of portfolio management, although it still preserves a more ‘static’ nature and a ‘lighter’ approach. More precisely, while the portfolio management service demands, in a strict sense, an on-going management of the portfolio in order to continuously monitor the optimal asset allocation, investment advice requires only a periodic assessment of the investment suitability (id est, an assessment that occurs on a regular basis, at regular periods of time). From this perspective, these two investment services seem to differ from each other not just as to their specific features and contents, but more importantly as to the ‘intensity’ with which such an assessment must be carried out by the distributor.

10. The ‘Advice Gap’ and the Need for a Broader Interpretation of MiFID II Inducement Provisions

The expected shift toward periodic advice will inevitably increase the costs associated with the provision of investment advice itself.

Accordingly, the new disclosure requirements over costs and features will have to play a key role in order to safeguard the efficiency of European capital markets.^[67] In particular, it is important that transparency, which stirs competition among distributors, would represent an effective deterrent for misbehavior, so as to guarantee that the expected growth of commissions would be linked to a corresponding increase in the quality and the actual value of the advice. From this perspective, FinTech can play an important role too, engaging financial firms in a vigorous competition and challenging most of the incumbents’ rent-seeking practices.^[68] At the same time, it is also important to adequately calibrate such disclosure requirements, so as not to result in a ‘race to the bottom’ on the quality of the investment products. In fact, once the costs of advice come into the spotlight, there is a concrete risk that distributors may attempt to overtake their competitors by offering (at lower cost) poor-quality investment products and services. They may be able to do this because the ‘quality’ of such services may be much harder to asses and more difficult to perceive than costs;^[69] similarly, while costs must be disclosed annually, the assessment of an investment product may require a much longer time horizon.

Anyway, as long as the expected rise in costs is effectively associated with the provision of higher-quality investment advice, fully coherent with the actual interest of the clients, there is little room for concern. The improvements in the protection of clients, the strengthening of investors’ trust in financial markets, as well as the increase of investment returns due to a periodic assessment of the portfolio, all seem to outweigh the costs that will probably stem from the new regulation of inducements.^[70]

10.1 Nevertheless, this shift towards periodic advice could also lead to other unintended consequences.

The actual advantages of high-quality investment advice inevitably shrink as the ‘size’ of the invested assets decreases, until the costs associated with the provision of periodic advice are no longer justified by the corresponding benefits. As a result, smaller investors, who have limited assets at their disposal, might be excluded from access to any kind of investment advice.^[71] Disproportionate in costs for clients and perhaps not even profitable for distributors themselves, in these situations, investment advice will be inevitably replaced by FinTech, thus worsening the problem of ‘advice-gap’ for smaller investors (at least in its traditional appearance).^[72]

On the other hand, it could also be questioned whether investment firms could even lawfully recommend periodic advice to such small retail investors; indeed, inducements must not “directly benefit” the distributor “without tangible benefit to the relevant client”^[73] and – in any case – they cannot be accepted “if the provision of relevant services to the client is biased or distorted as a result”^[74]. Therefore, it is doubtful that periodic advice – with its higher costs – could bring a “tangible benefit” to such clients, so to be deemed in their actual best interest.^[75]

10.2 While FinTech services – as already mentioned – could represent a cheaper but substantially comparable alternative to traditional investment spot advice, they may still give rise to serious concerns about investor protection.

It is well known that retail investors usually lack the appropriate financial knowledge to understand how investment products and capital markets actually work.^[76] In this respect – since financial education can represent only a partial solution^[77] – investors have traditionally sought professional advice in order to overcome such an asymmetry of information.^[78] For their part – at least, until now – FinTech firms have performed this task adequately. Yet, investors are also frequently prone to cognitive biases that may push them to “overvalue their competencies when self-rating their financial understanding”, thus inducing them to take disproportionate risks.^[79] Such cognitive biases clearly highlight the role that professional advisors actually play, even in the early stage of the relationship with their clients, by helping them to properly assess their own ‘investment profile’. Recognizing this potential bias, the EU regulator explicitly demands that financial intermediaries “take reasonable steps and have appropriate tools to ensure that the information collected about their clients is reliable and consistent, without unduly relying on clients’ self-assessment”.^[80]

Cleary, this latter, essential, function can hardly be performed by FinTech firms, which necessarily rely on clients’ self-assessment. Moreover, the critical issues related to such a self-assessment can only be mitigated by a careful inquiry, fully compliant with all the best practices outlined by the EU regulator in order “to check the reliability, accuracy and consistency of information collected about clients”.^[81] In this respect, the differences between FinTech services and traditional investment advice – even spot advice – are still significant, and the former cannot entirely replace the latter, despite the (formal) principle of “technological neutrality” envisaged by the European Commission.

Even more so, similar conclusions can be drawn if we broaden our analysis not only to the provision of investment services, but also to insurance, social security and credit services – services that most of the European ‘universal’ banks already provide.^[82]

11. A New Role for Financial Advisors: The ‘Simplified Advice’

Having said that, it should be examined whether MiFID II allows for alternative solutions that can pave the way for a ‘simplified advice’, so to reduce the aforesaid advice gap.^[83] In particular, since the list of conditions laid down by art. 11, para. 2, let. a, of the Delegated Directive for the collection of inducements is “non-exhaustive”,^[84] it should be investigated which features of the provision of investment advice: (i) while being ‘compatible’ with the business model of European distributors, (ii) could be deemed to enhance the quality of the service offered in a way that is compliant with the Delegated Directive, (iii) without enlarging the advice gap due to the excessive costs involved.

As already said, the Delegated Directive allows – under certain conditions – the collection of inducements even for merely executive investment services.^[85] With respect to these services, the only task performed by the financial intermediary is to reduce the transaction costs that may prevent investments from taking place (= finding a counterpart, drafting the contract, carrying out the operation); the distributor, instead, is not involved in the management of information asymmetries (not even in the weaker forms of spot advice) that usually characterizes every investment relationship.^[86]

Because clients, in such circumstances, are not helped by the financial firm in the early selection of investments, the EU regulator tries to ‘compensate’ for the lack of advice by demanding that the distributor offers, at least, a wide range of third-party investment products. In this respect, the broader choice and the resulting possibility to better compare different financial instruments, coupled with the new product governance regime, are supposed to protect investors adequately. Therefore, it seems correct to conclude that both traditional ‘spot advice’ and the ‘access to a wide range of investment products’ represent – at the very end – two alternative (but equal) solutions to the same problem of the initial construction of the portfolio (using math, this concept can be summarized as follows: spot advice = merely executive investment service + access to a wide range of third-party investment products).

On the other hand, art. 11 of the Delegated Directive deems periodic advice ‘comparable’ to the provision of any other merely executive investment service which may also grant: (i) access to a wide range of third-party financial instruments, relating to the initial choice of the investments, and (ii) “added-value tools” or other “periodic reports”, for the on-going management of the portfolio. Obviously – since investors need to deal with both the construction of the portfolio and its management on their own – the decrease in benefits for the clients demands also (iii) a corresponding decrease in the overall amount of commissions and costs. Using math one again: periodic advice = [(merely executive investment service + access to a wide range of third-party investment products)^[87] + added value tools and other periodic reports] * reduced commissions.

In this respect, it could also be asserted that the access to a wide range of investment products can be fairly substituted by the advice of the distributor on the initial construction of the portfolio (id est, by traditional spot advice, since the problem of the on-going management of the investments is still addressed by providing periodic reports).^[88]

Hence, it may be correct to conclude that investment firms can lawfully collect inducements even if they provide traditional spot advice when, in addition: (i) they grant “added-value tools” or other “periodic reports” that can help clients “to take investment decisions” and “to monitor, model and adjust the range of financial instruments” in which they have invested; and (ii) the commissions paid by the client are proportional to the quality of the investment services offered.^[89] For descriptive purposes, we may call this investment service ‘simplified advice’.

12. Concluding Remarks

As a generalized assessment of the conclusions reached in the previous section, this article identifies the apparent recurrence of two essential elements in every hypothesis laid down by art. 11 of the Delegated Directive for the licit collection of inducements. Indeed, such elements characterize MiFID II regulation and pave the way for the identification of new circumstances under which distributors can lawfully collect inducements, even outside the hypothesis explicitly listed.

In particular, these two fundamental elements are: (i) the provision of a ‘whole-comprehensive’ investment service, somehow capable of effectively encompassing every stage of the investment relationship, from the early assessment of clients’ characteristics and objectives to the on-going management of the investments; and, above all, (ii) the introduction of a strict proportionality test between the overall amount of commissions paid by the investors and the effective quality of the investment service provided by the distributor.^[90]

Such a proportionality test should play out within two different ‘poles’: on the lower end, FinTech services (especially robo-advisors), which can offer low-cost, high-tech, and standardized investment services based on the self-assessment of the investor; on the upper end, the provision of periodic advice, where clients are aided by the financial intermediary in every step of their investment.

Naturally, both sides of these ‘poles’ (more precisely, the overall amount of commissions and costs associated with each one) should be set only by market dynamics, so as to mitigate the risk that such a proportionality test may turn into a ‘paternalistic price regulation’. Nevertheless, art. 11 of the Delegated Directive could still pose some enforcement challenges. Indeed, the aforesaid proportionality test entails wide discretion, as well as a judgement on the ‘contents’ and ‘merits’ of the investment service provided,^[91] thus making such scrutiny not fully compatible with a competitive market environment, nor with the powers that can be lawfully conferred to an independent authority.

From this perspective, shifting the basis for such a proportionality test from an external comparison between the common market price and the price actually offered by a specific investment firm, to an internal comparison between the prices offered for different services provided by the same distributor (or by a different firm belonging to the same financial conglomerate) could represent a well-balanced solution.

In particular, since inducements are paid by fund managers regardless of the investment service that clients have actually benefited from, distributors may be induced to ‘spread’ the costs for the provision of high-quality investment services among all their clients, even among those who benefit from different, lower-quality services. The distributors would be even more incentivized to do so because these latter investors are more frequently prone to cognitive biases and cannot reliably and independently assess the real value of the advice actually provided, thus making transparency regulation less effective.^[92]

On the contrary, under this new approach, if financial intermediaries decide to offer different ‘kinds’ of investment advice in order to meet the varying needs of their clients, then they must ‘graduate’ the costs and the commissions connected to the features of each specific investment service, thus preventing distributors from collecting the same amount of inducements for qualitatively different services (it has to be considered also that investment firms cannot lawfully provide periodic advice to smaller retail clients if the costs of such a service are no longer justified by tangible benefits for the relevant investor).

On the other hand, the implementation of such a proportionality test does not appear to entail excessive costs for the distributors. Indeed, as pointed out by art 12 of the Delegated Directive on independent advice and portfolio management, investment firms could put in place “mechanisms for transferring to the client” the amount of inducement received not corresponding to the service actually offered.