EU ban on inducements to boost Europe’s ETF industry

Feb 9th, 2023 | By | Category: ETF and Index News

The European Commission is weighing up banning kickbacks that financial advisers receive when they sell investment products, a move that would drive greater uptake of low-cost products such as ETFs.

EU ban on inducements to boost Europe’s ETF industry

The European Commission is conducting a broad review of retail investment markets in Europe.

These kickbacks, also known as inducements or retrocession fees, are thought to distort the efficiency of investment markets and specifically harm retail investors who typically receive bad investment advice and pay above-market product rates as a consequence.

Critics of inducements point to a clear conflict of interest as financial advisers, by receiving commissions for the investment products they sell to consumers, are incentivized to recommend the highest-commissioned products rather than what’s best for their clients.

In order to pay the financial adviser’s commission, product providers may increase the fees of their products which makes them less beneficial for consumers.

The days of inducements may be numbered, however, as the European Commission scrutinizes the practice as part of a broader review of retail investment markets in Europe.

In a speech delivered to the European Commission on 24 January, Mairead McGuinness, European Commissioner for Financial Stability, Financial Services, and the Capital Markets Union, noted that retail investment products containing inducements were, on average, more than a third (35%) more expensive compared to similar products without the kickback commission.

McGuinness said: “We need to ask ourselves whether commission-based models really work in the interests of retail investors. I want consumers to have access to financial advice, but biased advice does not serve them either.”

A ban on inducements is expected to drive growth in Europe’s ETF industry as these low-cost funds are currently hardly ever recommended by financial advisers receiving kickbacks.

Commenting on the potential ban, Michael O’Riordan, Founding Partner of ETF and Digital Assets consulting firm Blackwater Search & Advisory, said: “To us, retrocession fees or inducements are the cancer of fund distribution in Europe (and Asia). Inducement or retrocession fees are screwing retail investors across Europe and Asia and have been doing so for a very long time now. How can anyone claim to provide ‘independent advice’ if they are receiving a kickback on the products they are recommending? That is a massive conflict of interest.

“ETFs are wonderful investment tools for everyone, but most ‘advisers’ don’t want anything to do with them simply because they don’t pay commission. A ban on inducements would level the playing field and should give investors access to better choices. Surely that can only be a good thing.”

Caroline Baron, Head of ETF Distribution, EMEA, Franklin Templeton, added: “Inducement bans are fundamental to ensure ETFs are on a level playing field with other investment vehicles when it comes to retail investing. This is how we saw a boom in the ETF business in the US where there is an equal split between retail and institutional users, versus less than 10% retail ETF uptake in Europe.

“ETFs are a simple, low-cost option for many retail investors and whilst an inducement ban would significantly boost retail ETF investment, there are also other factors at play. For example, insufficient investor knowledge about ETFs and investment platforms being less accommodating to ETF tools mean the European ETF market still lags.

“However, we expect to see an increase in ETF adoption by retail investors as the intergenerational wealth transfer is realized coupled with model portfolios, investing apps, and robo-advisers, which are growing in popularity due to enhanced digitalization of the industry, and as investors increasingly want simple products at low costs, as the impact of fees on returns continue to be scrutinized.”

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