Capital Markets Union: the future lies with the better advised consumer-investor

On the 24^th of September, the European Commission revealed its new plans for the Capital Markets Union (here and here). With the post-coronavirus recovery in mind, the European Commission suggested a 16-point Action Plan. The Action Plan highlights the struggles that many businesses face in order to stay solvent in the medium and long term. When it comes to consumers, the new Action Plan intends to increase consumer choice regarding savings and investments, which involves better information and better overall protection. The European Commission also makes the case for market-based pension systems, in order to meet ‘the challenges posed by Europe’s ageing population’. 

In particular, the Action Plan highlights that while Europe has one of the highest saving rates in the world, the level of individual investment remains low. In order to increase individual investment, the EU Commission promises to increase trust in capital markets by improving financial literacy. Additionally, the Action Plan highlights the importance of harmonizing disclosure duties on investment products so as to increase comparability of similar products that are currently covered by different legislation. In this sense, the Commission promises to assess whether it can introduce a requirement for Member States to promote educational measures in relation to responsible and long-term investing. Understandable information also plays a central role in the Commission’s plan of attracting more individual investors. In particular, the Commission stresses that although there are already duties in place that impose the disclosure of financial information, the documents produced under those rules are considered ‘long, complex, difficult to understand, misleading and inconsistent’. Additionally, these documents may result in information overload. In this context, the Commission distinguishes between the sophisticated investor – who does not need as much information – and the inexperienced investor – who needs more information. The Commission commits to looking into the applicable legislation and amend it so as to guarantee that consumers receive ‘clear and comparable product information’.

Additionally, the Commission promises to improve the regime applicable to retail investment, to guarantee that an individual investor benefits from, among other aspects, bias-free advice. The importance of transparent information and bias-free financial advice cannot be understated. Financial advisers must be obliged to disclose their own interest in the sale of a given financial product. As BEUC also highlights here, biased financial advice has resulted in considerable financial losses to consumers all over Europe in recent years (see, for example, the case of Banco Espírito Santo in Portugal). In this regard, the Commission acknowledges financial advisors’ role as gatekeepers of the financial system. As a specific point of action, the Commission promises to work towards the harmonization of the threshold of professional qualification of financial advisors, in order to increase consumers’ trust in their advice.

The scope of non-standardized information provision under Directive 2008/48/EC- CJEU judgment in C-58/18 Schyns

A couple of days ago the CJEU delivered its judgment in case C-58/18 Michel Schyns v Banifius Banque SA. Luckily, the CJEU proceeded to decide on the merits of the case in spite of the vagueness of the application (see our report on AG Kokott's opinion in this case here).

The facts of the case

To remind ourselves, this case concerns the interpretation of Directive 2008/48/EC on Consumer Credit. In 2012 Mr Schyns concluded a contract with Home Vision for the installation of a photo-voltaic system (i.e. a solar power system) for the price of 40 002 euros. A couple of days later, Mr Schyns concluded a loan contract with the predecessor of Banifius Banque SA for 40 002 euros repayable in the next ten years in monthly installments of 472,72 euros. The loan was issued to Mr Schyns who subsequently transferred it to Home Vision. The photo-voltaic system was never installed, and Home Vision subsequently declared bankruptcy. In 2016 (after paying the installments for over 4 years) Mr Schyns commenced an action against the bank for setting the contract aside and terminating future performance.

The legal issues

This case raised interesting issues on the compatibility of Belgian law with Art. 5(6) of the Directive:
1) Are the rules requiring creditors to select a credit product suitable to the needs and the financial situation of the consumer incompatible with the above provision?
2) Are the rule requiring creditors to refuse to lend to consumers that cannot afford the loan contrary to the said provision?

The scope of 'adequate explanations' in Art. 5(6) of the Directive
The CJEU followed AG Kokott's opinion and answered the first question negatively. It is therefore not contrary to Art. 5(6) of the Directive for national laws to require creditors to recommend the most suitable loan taking into consideration the purpose of the loan and the consumer's financial situation at the time when the contract is concluded.
Given that the Directive does not provide for this obligation, and being a full harmonization instrument, one might question whether the Member States may go beyond what is provided in the provision. The CJEU is of the opinion that they can because of the last sentence of Art. 5(6) of the Directive provides that the Member States may adopt the manner in which and the extent to which 'adequate explanations' are given (para. 29). According to the CJEU, adapting the manner and extent of adequate explanations can extend the creditor's obligation to select the most suitable loan. The CJEU also supported its reasoning by reference to Recital 27 and Art. 5(1) according to which consumers may need additional help in selecting the right credit products for their financial needs and wants (para.30), and creditors, as professional lenders are best placed to provide this help to consumers (para. 33).
The CJEU reiterated that, on the one hand, consumers need pre-contractual information to make informed decisions; on the other hand, this pre-contractual information might need to be supplemented with more personalized information for making a fully informed decision (para. 34). However, the CJEU also emphasized that despite the obligation of the creditor to inform consumers and even to select the right credit product consumers to stay ultimately responsible for the choices they are making (para. 34).

Refusing to lend under the Directive
The second question answered by the CJEU tackled the extent to which the selection of the right credit product can reach. What should creditors do if in selecting the suitable credit product they consider that consumers cannot afford any loan?  Here too, the CJEU agreed with AG Kokott's opinion that it is not incompatible with the Directive for national laws to provide for an obligation to refuse to lend in a situation where creditors cannot be confident that consumers can dully fulfill their contractual obligations, i.e. pay the loan installments as they fall due (para. 49). Although the Directive does not directly provide for this obligation, this interpretation is compatible with  Art. 8(1) of the Directive on responsible lending and creditworthiness assessment and with the broader EU consumer policy reflected in Art. 18(5) of Directive 2014/17/EU that directly provides for an obligation to refuse to lend (para. 46).

Our evaluation
This is an important judgment that aims to clarify the scope of Art. 5(6) of the Directive. It does extend the scope of the provision and clarifies that adequate explanations can go beyond mere explanations of standard information provided within the Directive; that creditors may also be obliged to select or recommend the suitable loan for consumers (taking into consideration the consumers financial situation at the time when the contract is being concluded and the purpose of the loan). It remains however unclear whether this means an obligation of the creditor to provide financial advice? AG Kokott seems to have thought that it does, however, the court does not make any specific reference to financial advice. Financial advice being an independently regulated activity raises the doubt that it falls within the scope of the Directive. It requires licensed financial advisers (and not every bank clerk dealing with loans will comply with this requirement) and the advisers should take at least some responsibility for the advise they have provided. Given the final reservation of the CJEU that consumers bear the ultimate responsibility for the taken loan leads me to think that adequate explanations do not extend as far as the provision of financial advice. This remains an interesting question though that will need clarification in the future. We may also think whether the question of responsibility is adequately addressed by the CJEU. If creditors are obliged to select the right or suitable loan for the consumer, should they not take the responsibility for it then?

The second aspect of the judgment is also an important development in clarifying the scope of the Directive. Given the full harmonization nature of the Directive and its silence on the creditors obligation following a creditworthiness assessment, the CJEU's contribution to consumer protection by specially enabling Member States to provide the sanction of refusal to lend is an important one. Probably following Directive 2014/17/EC, the CJEU highlighted that the bank should refuse to lend any time it estimates consumers are unable to fulfill their payment obligations as they fall due, arguably aiming to observe the goals of sustainable lending.

FCA report on debt management firms: A long way to go to address consumer vulnerabiltiy

On 15^th March 2019, the UK regulator for financial services, the Financial Conduct Authority (FCA) published a report on consumers and debt management firms. The report focused on the impact of advice provided by debt management firms to vulnerable consumers. This report comes shortly after the publication of the Access To Cash review report on the declining use of cash in Britain and its impact on vulnerable consumers (you can read the blog post on that report here.  

This publication is a follow-up on the 2015 review of the sector conducted by the FCA. The FCA is a newly established authority and these reviews have the dual aim of assisting the FCA in gaining a better understanding of the sector as well as an nudge to traders to increase their standards (though the report does not set any goals). For the report a sample of 12 firms was selected including both commercial debt management firms and not-for-profit debt advice bodies.

The results of the 2015 review were grim, exposing an unacceptably low standard of services, especially by commercial fee paying firms and a high risk of detriment for vulnerable consumers. Has the situation improved since then?

The 2019 report shows that there has been an improvement, and commercial firms tend to be more customer-focused now, compared to a few years ago. However, there is still a long way to go for improving standards in the area. The two main areas identified for improvement are:

1) Debt advice given to customers seeking help together or who are already on a joint debt management plan.

Firms often treat consumers as a unit and fail to provide them with options that apply only to one of them, meaning they may lose out on a more favourable solution.

2) The identification and treatment of vulnerable customers. 

While most firms have good intentions, they do not have the proper procedures in place, quality assurance and staff training for identifying and assisting vulnerable consumers in an appropriate manner. Consumers’ vulnerability or vulnerabilities may go unnoticed or unrecorded. Worse yet, it may be identified only to later be buried under a pile of documents or processes and not accessible to the next person handling the case. 

Identifying consumer vulnerability has a severe impact on the advice that should be provided to these consumers and how they will respond to it. Firms need to take the circumstances of each consumer into account, also in the advice provided.

Furthermore, the report point out that there is no one-size-fits-all when addressing vulnerability and firms should be flexible and be able to adapt to the needs of vulnerable consumers where necessary. Some firms have done that successfully by creating specialist units that receive further training and had greater autonomy within the company on how the communicate with customers. Such specialist units could be key in addressing the needs of vulnerable consumers.

The report is a welcome development to bring attention to the needs of vulnerable consumers of financial services and the FCA is showing its commitment to pursue this agenda further by taking action against firms as well as publishing a new guidance on vulnerable consumers.

The role of consumers in supporting sustainable finance

The EU Commission recently took up the task of joining international efforts (the UN 2030 Agenda and Sustainable Development Goals, and the Paris Climate Agreement) in taking due account of environmental (ie. climate change mitigation and natural disasters) and social considerations (inequality, inclusiveness, and investment in local communities) in investment decision-making, with an aim of leading to increased investments in longer-term and sustainable activities- this process is generally referred to as ‘sustainable finance’.

In order to integrate sustainable finance into its law and policy making, the EU Commission established a High Level Expert Group on Sustainable Finance in 2016 and based on their recommendations adopted the Action Plan: Financing Sustainable Growth in March 2018.

The Action Plan sets out an ambitious plan to transform the EU economy into a greener, more resilient and circular system that will reduce its environmental footprint and address existing inequalities. This entails a holistic transformation of the relationship of the economic agents i.e. public and private institutions, small and large businesses and consumers with the environment.

The primary aim is to orientate capital flows to a more sustainable economy.  To this end, the EU Commission first proposes to clarify what is meant by ‘sustainable’ finance via the creation of EU taxonomy of sustainable activities; than building on the taxonomy, to develop standards and labels for sustainable financial product. Businesses are encouraged to design their business models and to develop strategies and technologies that support the long term effects of their investment. Investment fund managers will be obliged to take sustainability considerations into account when acting in the best interest of their clients, and to inform the end investors about the impact of sustainability considerations on their decision and the investors exposure to sustainability risk, for example, climate related risks. The EU Commission also considers factoring in sustainability risks into calculating capital adequacy of banks and insurance companies. The final really interesting addition is a ‘sustainability benchmark’ that will properly measure the performance of sustainable investments. While benchmarks play a central role in the formation of prices of financial instruments (see our report here), the current benchmarks are not designed to reflect on sustainability considerations.

Following the Action Plan in May 2018 the EU Commission adopted a package of measures implementing several key actions laid down in the Action Plan: 1) To create a unified system of classification of sustainable activities it adopted the Proposal for a regulation; 2) To introduce disclosure obligations of investment fund managers it proposed a Regulation amending Directive 2016/2341; 3) Finally, to create a new category of low carbon and positive carbon impact benchmarks it proposed a Regulation amending the Benchmark Regulation.

Naturally, most of the measures set out in the Action Plan are designed to be addressed by private and public businesses. However, the EU Commission has also seen consumers as part of the picture. So what are the role consumers in channelling financial assets towards a sustainable growth?

Well, just as businesses, consumers can also consider the sustainability of their investment decisions. To this end, the above mentioned taxonomy of sustainable activities and labeling of financial products as sustainable could help consumers in their decision making. These are however not specially designed consumer information tools. It seems that the EU Commission did not envisaged independent decision making by consumers. The Action Plan only foresees the regulation of financial advice for investment and insurance products. The Commission (perhaps rightly) assumes that we will not be able to make smart investment decisions on sustainability considerations without financial advice. Do you agree with this approach? Are we incapable to make independent decisions on complex matters such as the sustainability of investment?

Given that financial advice is seen as having a central role in the EU Commissions regulatory approach, we may wonder whether sufficient safeguards are taken into account against mis-selling of sustainable financial products (see our report here). Prior to providing financial advice, the advisers are obliged to assess the consumers risk appetite and investment objectives, including their alignment with sustainability (i.e. environmental, social and business governance factors). However, without proper safeguards consumers may be offered more risky or more expensive sustainable products to invest than they would expect. The EU Commission must make sure that appropriate safeguards are in place, that only those consumers willing to pay more for a moral satisfaction of investing into sustainable projects  are being offered such products, and that these products conform to the individual consumers risk appetite. This is a factor that should be taken into account in formulating the amended rules for MiFiD 2 and Insurance Distribution Directive (IDD) (on which the EU Commission is currently working on).

The other aspect that could be taken into in formulating the rules and policy approach is account is whether consumers need sustainable products, whether there is demand for them. European states are likely to be divided on this aspect. In some Member States consumers may be willing to investment in more risky or more expensive products to support the causes they believe in, whereas in other Member States consumers will only care about the price of the product and the security of their investment. Probably the higher the living standard is the more consumers are inclined to pay attention at sustainability goals. Should the EU Commission direct its activities towards Member States where consumers are more receptive to sustainable finance, or is the phrase ‘think global, act local’ equally applicable here?

Finally, it strikes me that the current approach is somewhat limited to certain investment products, to those provided by investment firms (regulated under MiFID2) and insurance distributors (regulated under the IDD). Any wider effort of engaging (or at least attempting to) on sustainability goals is not attempted.  We are not for example expected to choose our bank based on their ethical policy or the pension fund that we pay into. Should the EU Commission have a more systematic approach, make a wider appeal to sustainable finance that goes be beyond amending the MiFID 2 and the IDD?

Mis-selling of financial products: is there a need for a systematic approach?

As we are more and more expected to take control of our financial affairs e.g. to save for our retirement or to take up a mortgage loan to finance our house, financial decision-making is increasingly becoming part of our lives. Yet, at the same time, financial products are becoming overly complex, markets too diverse, and our financial decisions ever more important. Given the importance of these decisions, many of us would decide to get help from a financial adviser rather than to making an independent decision. We tend to trust financial advisers, trust that they are going to select the right product for us, the one that is the best fit for our needs and preferences. But are we really getting the right product? The financial mis-selling scandals suggest that we are not.

 

Unfortunately, mis-selling scandals because of bad advice are too common in Europe. Many of these scandals will be (too) familiar to our readers, such as the PPI scandal in the UK, the foreign currency loans in several Member States e.g. Spain, Greece, Hungary, Poland, or risky investment products in e.g. Belgium (see the map of major mis-selling scandals, including videos of testimonies here). More recently financial advice also got the attention of EU law-makers. In June 2018 the EU Parliament published a series of five studies on Mis-selling of Financial Products: 1) Marketing, Sale and Distribution, 2) Subordinated Debt and Self-Placement, 3) Consumer Credit, 4) Mortgage Credit, and 5) Compensation of Investors in Belgium. These studies pointed out the weaknesses in the current EU regulatory framework and its enforcement. In addition, in April 2018 the EU Commission published a study on the Distribution of retail investment products across the EU, concluding that consumers face significant challenges in making informed decisions (see our report here).

 

In the light of the above, BEUC launched a campaign for a real change in the financial advice sector. A change that needs to affect: sales incentives, regulatory framework and supervision and enforcement.

• Mis-alignment of sales incentives is a real problem in the financial advice sector. Commissions create a conflict of interest, steering advisors in a direction of offering risky products instead of acting in the best interest of consumers.
• According to BEUC, the current, patchy legal framework is not fit for purpose. As we know, the majority of legislative instruments, especially those adopted in the aftermath of the financial crisis, will regulate at least some aspect of financial advice. However, this approach creates inconsistency, for example, the regulation of issues like independence and qualifications are approached differently in various instruments, without even having common definitions of what they are referring to.
• Finally, many of the current rules is difficult to enforce, for example, the requirement in MiFID2 that the investment meets the needs of the consumer.

To improve the financial advise sector, BEUC suggests to: 

• ban commissions;
• create common definitions and rules for advisors, rules that set standards of professionalism and that are easy to comply with;
• better enforcement, enforcement coordinated by the EU supervisors (EBA, ESMA and EIOPA) and adequate powers of national supervisors.

Whilst it is not specially raised, it could be implied that that the above aims would be the best achieved by a separate, independent act such as a Directive on Financial Advice. What do you think?  Is there a need for a systematic approach? Is it viable to regulate financial advice independently from the underlying product that it relates to?

The risks and benefits of automated financial advice

In December 2015 the three European Supervisory Authorities (ESAs) (the European Banking Authority, the European Securities and Markets Authority, and the European Insurance and Occupational Pensions Authority) issued a joint Discussion paper on automation in financial advice.

The ESAs have recognized that with increasing digitization of financial services, more and more financial institutions offer automated financial advice to their customers (also called 'robo-advice').Thus the Discussion paper is aimed at assessing what (if any) regulatory/supervisory action is required to enable consumers and firms to take advantage of the benefits and to mitigate the potential risks, of automated advice. The Discussion paper explains the concept of automated advice, and highlights the possible risks and benefits of this innovation.

Automated advice means that a recommendation to buy or sell financial products is generated by automated tools (typically websites using algorithms or decision trees) without (or with very limited) human intervention.

The ESAs believe that automated financial advice may be beneficial for consumers in terms of providing easy access to a quality service (free from behavioural biases, human error or poor judgment and reliant on a large volume of complex data) at a considerably lesser cost than traditional advice. However, they also recognize that automated advice may carry a great deal of danger. Importantly, consumers may find it more difficult to understand automated advice than traditional advice without a human interaction and being able to ask questions and seek clarifications; consumers may misunderstand the nature of the advice (they may receive general advice but believe that they have received personalized advice); consumers may end up with unsuitable advice because they do not understand how information is used by the automated tool and enter incorrect or incomplete data, or because of a failure in the automated tool itself. Finally, automated financial advice, as with any digital service, raises data protection issues.

The consultation period ended in March 2016. The Discussion paper generated great interest among the stakeholders and the ESAs have received many responses. BEUC welcomed the ESAs interest in automated financial advice, and considered the Discussion paper to be a well balanced discussion of the risks and benefits of automated advice. It has however highlighted that protecting consumers in this area will require new approaches, and that market outcomes may largely depend on the quality of algorithms used for guiding consumers through the advice process.

What do you think? Is automated advice more likely to benefit or to harm consumers?