NEWS & VIEWS. Global Trustee and Fiduciary Services

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1 4 Can Asia Fund Passporting Emulate the Success of Europe s UCITS? A look at funds-passporting schemes announced across Asia and their chances of success. 13 Capital Markets Union: What Is It and What Does It Mean for the Market? An overview of the flagship programme at the heart of the EC s growth agenda. 19 SEC s 2015 Exam Focus A summary of the examination priorities published by the OCIE. 22 The New Transaction Reporting Requirements of MiFIR. An overview of the new reporting regime and its impact on asset managers. Global Trustee and Fiduciary Services NEWS & VIEWS Global Trustee and Fiduciary Services News and Views First Edition 2015

2 Global Trustee and Fiduciary Services News and Views First Edition Tougher Rules Than MiFID II: Sweden May Implement a Ban on Third-Party Commissions and Fees for All Types of Investment Advice and Portfolio Management Services In Sweden, the government s MiFID II Review Panel proposes that Sweden should go further than the directive when it comes to the prohibition of accepting or retaining fees or commissions from third parties. While MiFID II limits this prohibition to situations where investment advice or portfolio management services are provided on an independent basis, Sweden may impose tougher rules where all fees and commissions in such situations are prohibited if they could have a negative effect on the interests of non-professional customers. The fees and commissions that may be subject to this prohibition are to be decided by the Swedish Financial Supervisory Authority (SFSA) in regulation yet to be proposed. Is this the right way to go? A booming Swedish retail market for investment products In the last 10 years, Sweden has experienced an expansion of the investment fund and structured products markets. The market for investment funds, introduced in the 1990s, has experienced a substantial growth to date. This is both a consequence of the general increase of household savings in mutual funds and of the reformation of the Swedish pension system, allowing Swedish citizens eligible for pension to opt between different investment funds that have been selected for the public pension savings scheme. The market for structured products has experienced a similar development during last 10 years, where the primary market for structured products has been made accessible for the retail market and where a large number of different structured products have been packaged to suit retail customers. Statistics are evident: a recent study made by the Statistics Sweden showed that the accumulated savings in financial products by Swedish households increased by some SEK1500 billion between 2002 and While wanting to make the most of this business opportunity in the retail market, Swedish small- and mid-sized securities firms and fund managers faced great competition from the four dominating Swedish banks, with substantial capacity to distribute financial products to retail investors through their many local offices across Sweden. This led to a development where other means for distribution were explored, including telemarketing, internet sales and the increased use of smaller securities firms or insurance intermediaries as end-distributors. As for insurance intermediaries, such intermediaries were used to market (arguably outside the scope of regulated investment services) financial instruments directly against end-consumers or to sell endowment insurance solutions linked to financial instruments, including tax-efficient solutions whereby

3 66 Markets and Securities Services Sweden

4 Global Trustee and Fiduciary Services News and Views First Edition endowment insurance is linked to custody accounts where the customer is free to trade over the account. An interesting fact in this context is that the number of insurance intermediaries in Sweden has more than doubled during the last 10 years. The number of fund managers and smallto mid-sized investment firms specialising in structured products has increased. The bulk of investment advice is provided by the producers of financial instruments (such as banks, investment firms and insurance companies) and intermediaries (such as smaller investment firms and insurance intermediaries). In such cases, the intermediary has an economic arrangement with the producer. This has led to a situation where close to all intermediaries are connected to a producer of some kind and where there are close to no independent investment advisers that charge customers directly for investment advice. It has also meant that new intermediaries are entering the market with a view to benefit from the lucrative opportunity to distribute financial instruments to retail customers. However, not all of them necessarily possessed the right competence, knowledge and experience to be able to sell more complex products or to provide investment advice for them. Problems associated with remuneration to distributors Intermediaries are customarily paid by up-front fees, kick-backs or other shared commission arrangements. Such fees and commissions are often built into the price and therefore create difficulties for customers to understand what inducements drive the sales and the sales behaviour. This difficulty is further emphasised in connection with sales of more complex products or combination of products. This has inevitably led to problems. Retail customers have understandably a difficulty in knowing or identifying a difference between investment advice and pure sales. Furthermore, in many cases investment advice has lead to transactions that were not necessarily in customers best interests. These developments led to the SFSA increasing its supervision in this field. The debate in Sweden over the last four years, very much lead by the SFSA and commented on in its annual supervisory reports, has very much been focused on consumer protection. Moreover, the SFSA concluded that inducements in connection with the sale of financial instruments created conflicts of interest where customers interests in getting suitable advice have been set aside by advisers interests to make sales and earn commissions. This has also resulted in sanctions by the SFSA. During the last four years, the SFSA decided in several cases to administratively fine investment firms and insurance intermediaries that did not meet the requirements to act in the best interest of clients or to meet the legal requirements for sound advisory standards. These cases were only the tip of the iceberg. There were many other cases where the SFSA, for different reasons, chose not to intervene by way of sanctions. Another common denominator in these cases is the customer having difficulty understanding what fees, commissions and kick-backs are associated with products. The firm selling the product, furthermore, had failed to provide sufficiently clear information about such fees and commissions. There were also issues relating to insufficient knowledge and experience of the investment advisers. Given the need to review Swedish legislation in relation to the implementation of MiFID II, the government took the opportunity to request that the MiFID II Review Panel come up with regulatory solutions to the problem relating to fees and commissions for financial advisory services. In its work, the Review Panel has taken into account the legal developments in other countries, in particular, it seems, in the UK. Is the UK model suitable for Sweden? In 2012, the UK introduced a requirement that personal advice could only be remunerated by advisory charges and commissions. Remuneration or benefit of any kind from a third party was banned. This regulation was a product of the Retail Distribution Review (RDR), a project that launched in 2007 with a view to enhance consumer protection in the UK retail market. What is interesting when comparing the UK market with the Swedish market is that the UK market is in many ways different. In the UK, there is a much higher share of independent investment advisers, i.e. advisers who provide advice on the basis of a sufficiently broad analysis of available

5 68 Markets and Securities Services Sweden A ban on commissions would probably lead to a reduced availability of investment advice for retail customers, in particular customers with smaller amounts of money to invest. products on the market. It is also a much bigger market, not dominated by four big banks as in Sweden, and where market conditions presumably allow for a bigger variety of business models and actors when it comes to investment advice. The problems for retail investors in the UK market that were addressed by the RDR-project in many ways have similar characteristics as the problems in the Swedish market. However, there are profound differences too. The UK s regulatory recipe for dealing with the problem in the UK may very well be equally effective if applied in Sweden. But the consequences for the Swedish financial industry may be quite different. The reason is simple, but evident: independent investment advisers do not suddenly appear out of thin air. Apart from the UK, the Netherlands has implemented a similar ban on inducements. But the Review Panel s proposal seems more aligned to the UK regulation than the Netherlands. The Swedish Proposal In January 2015, the Swedish MiFID II Review Panel presented its impressive review of regulatory actions required for Sweden to implement the directive. It also provided a proposal on how to deal with problems associated with the Swedish market concerning investment advice and consumers. The Review Panel s proposal was to implement a rule in the Swedish Securities Markets Act, providing that an investment firm (including banks that carry out investment services) may not receive remuneration from a third party when investment advice or portfolio management services are provided to non-professional customers if such remuneration can have a negative effect on the customers interests. Further, the Review Panel suggested that this rule should also be extended to apply to insurance intermediaries, thereby covering the entire chain from the producer to the distributor. Looking at this part of the provision, we see it is far from controversial. It is a well established principle in Swedish law that investment firms have a general obligation to always act in the best interests of clients. However, and more importantly, the Review Panel also suggested that, as regards the type of remuneration that could have a negative effect on consumers interests, the SFSA ought to be given the power to specifically regulate what types of remuneration should be prohibited. Accordingly the hot potato was passed on to the SFSA, which now has the task of deciding what type of remuneration should be forbidden. Consequences of the proposal The Swedish market for distribution of financial instruments to retail customers outside the spheres of the dominating big banks has by necessity been built up by smaller firms forming alliances and means for cooperation to reach a broader customer base. Such distribution is built on the ability to pay for the distribution. Accordingly, we have currently close to no independent investment advisers who charge customers for investment advice. The investment advice that is provided has instead been financed by other means, one example being reallocation. This is the effect when management fee-sharing arrangements are based on commissions that relate to the size of the invested amount. The investment advice for customers who invest a lower amount is financed by wealthier clients who invest a larger amount, i.e. there is a reallocation of commissions and fees for the benefit of the smaller customer. A ban on commissions would probably lead to a reduced availability of investment advice for retail customers, in particular customers with smaller amounts of money to invest. Intermediaries and advisers who are not employed by the big banks would be among the losers, but also producers, such as fund managers and investment firms, acting independently from the big banks. This, in turn, would lead to lesser competition as regards investment advice and savings products. While the Review Panel acknowledges these disadvantages in its proposal, it nevertheless argues that such disadvantages should be manageable by only making such fees and commissions subject to a ban to the extent they have a negative effect on customers interests. But is that really true? The answer to that question really depends on how the SFSA chooses to regulate the matter. Regulatory options for the SFSA The Review Panel s proposal gives the SFSA a mandate that allows it to regulate what commissions and fees should be prohibited. Unless specifically instructed by the government, the SFSA may, in theory,

6 Global Trustee and Fiduciary Services News and Views First Edition choose not to regulate the matter. In such a case, the proposed rule in the Swedish Securities Act would stand alone and be subject to interpretation as to what fees and commissions do not have a negative effect. For the sake of clarity and foreseeability, it would be better in such a case if the SFSA chose to regulate. If it did, the best guess is that the SFSA would probably issue a regulation that would prohibit the use of third-party remunerations in a similar way as in the UK, i.e. banning everything but up-front payment for investment advice. Another way to go about this would be for the SFSA to issue guidelines (allmänna råd). This is a regulatory tool very much similar to guidelines issued by ESMA, i.e. rules that you may deviate from by applying a comply or explain approach. If you chose to deviate from the guidelines, you would be obliged to explain how you intend to comply with the underlying mandatory provision on which the guidelines rely. This option is available for the SFSA without any changes to the Securities Markets Act now proposed by the Review Panel. However, the SFSA is not likely to use this option, even though it would probably be a better way to deal with the matter. What else can be done? It cannot be argued that there is no problem in the Swedish market, and clearly we need to change something in order to create a sounder market for investment advice. The question is how. If you ask the legislator or the SFSA, it seems the only way to go about this is to throw more mandatory rules at the problem. In this case, it means rules prohibiting certain behaviours, further limiting the possibility of making room to explore alternative solutions. The Review Panel s proposal fails to address two important issues. The first issue is whether it is the role of the legislator to create rules that have a major and immediate impact on how a free market is operating. The most serious aspect of that is it seems to enhance oligopoly rather than stimulate competition. The second issue is that the proposal interferes with the principle of freedom of agreement, as it restricts market participants ability to agree between them as they see fit. Turning this round and looking at the problem from another angle, it seems obvious that all market participants would benefit from a higher degree of confidence from retail investors that would presumably come from further transparency when it comes to fees, commissions and other benefits. Following the debate in Sweden and the sanctions decided by the SFSA, there has also been a shift towards increased transparency and better awareness among retail investors as to what to look out for when assessing different investment services providers and investment alternatives. While there is still much left to do, it does indicate that there is a willingness to make a change, though changing business models takes time and it is also a risky thing as untested business models may fail. There is also the first mover problem, i.e. you do not want to go first if you do not believe the others will follow. The key to solving that issue would be to look to self-regulation. Sweden has a long tradition of self-regulation in the financial market. We have also strong self-regulatory organisations (SROs) for market participants. Among them are the Swedish Securities Dealers Association, the Swedish Bankers Association and the Association of Swedish Insurance Intermediaries. One route to explore would be for SROs to look to issue guidelines applicable to all relevant members. Such guidelines could address how remuneration models need to be designed to preserve clients best interests. Two things could possibly be achieved by this. The first would be sufficient time to adapt to new business models without putting business at risk; the second, to create more room to manoeuvre and to explore alternative solutions that could achieve the same goal. However, it can be assumed that it would not be an easy task for the SRO members to agree on the contents of such guidelines. There is also the question of whether or not it is too late for the SROs to take back the initiative from the legislator. But if they do not, it is not a bad bet that third-party fees and commissions in connection with investment advice will be prohibited entirely. Mattias Anjou Partner Hammarskiöld & Co