Yet another regulatory myth explained

Nobody in the financial industry could have missed how notable the attention has been in all recent regulations paid to the conflict of interest and its mitigation. All those MiFIDs, IDDs, MCDs and other Directives, have substantial parts dedicated to so called “inducements”. This is a euphemism for preventing the advisors (distributors) from taking too much money that would skew their advice and recommendation to clients. Because even a little kid knows that those essentially undesirables in the financial world (we love Fintech!) will recommend even the worst product with the highest commission, right? Wrong.

As with many presumptions of current consumer protection dogma, this cliché has very little empirical backing. Considering investments, as the most observed segment, even scholarly literature is deeply divided, as to whether higher commissions lead to worse advice or not. Seeing this and the huge costs incurred by the colossal inducements’ regulation, I decided about two years ago to take a look at the situation in Central-Eastern Europe. That “wild East” of the European Union, which is not empirically mapped at all. So, what was our journey and what have we found?

Our research, which will be published in a few months in one of the prestigious European journals, was based on the examination of a total of 2,066 advised sales realised between 2013 and 2015. Using a quantitative model, we have examined whether, in those sales, the amount of commission paid to the final adviser had anything to do with the costs, yield or volatility of the recommended investment product. Participating companies were divided according to their sales model (MLM, pool or flat structures) and their size, to make results most granular. We certainly had many expectations regarding the outcomes, but what we found surprised us all. Although we have observed a relationship between commission and sold product costs, this was for the biggest part of the market (MLMs) compensated (for the investors) by significantly higher returns from the recommended funds.

How can we interpret such an outcome? Well, simply put: the majority of financial advisers recommend products with higher fees, but also higher returns. Does this suggest the consumer detriment that the Brussels legislators’ are claiming? Hardly. Because, on the negative side of the equation, the consumer must also add the costs of the regulation itself. Which are, unsurprisingly, enormous and are already pushing smaller companies out of business. Sceptics might ask: is this not the true goal of the regulation storm that we are enduring, despite the rhetoric about “smart regulation? Only time will tell.

The paper referred to above can be accessed here and the previous author’s work on the topic at both here and here.

By Jiří Šindelář
Broker Consulting, a.s.
former Deputy Chairman of FECIF