Launch of the Financial capability framewok for adults in the EU

We have reported earlier on the joint EU/OECD project on developing the Financial competence framework for adults in the European Union. On 11 January 2022 this framwork has been launched (see the recording of the event here).

The framework promotes a shared understanding of the financial competences adults need to make sound decisions on personal finance. It supports public policies, financial literacy programmes and educational materials to be developed by Member States, educational institutions, industry and individuals. It also supports the exchange of good practices by policy makers and stakeholders within the EU.

Aftre the launch of the framework, the focus is now on its uptake by relevant stakeholders. In parallel, the Commission and the OECD will start work on developing a similar financial competence framework for children and youth, which is expected next year.

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.

Would you trust your retirement to a pan-European personal pension product?

In June 2017 the EU Commission adopted a proposal for a Regulation of pan-European personal pension product (PEPP). As any other personal pension product PEPPs are intended to be long term investment products that complements state and workplace pensions and that consumers sign up for on voluntary basis. PEPP will be an addition to the existing markets for pensions, and will not replace or harmonize national personal pensions schemes. Given the recent attention to this Proposal, having just been approved by the Parliamentary Committee for Economic and Monetary Affairs (on 3 September 2018) we thought the proposal finally deserves to be commented on our blog. So what is special about PEPP and would it benefit consumers?

Who will offer PEPPs?

PEPPs may only be designed (manufactured) and sold (distributed) by EIOPA authorized firms in accordance with the conditions laid down in the proposed Regulation (Art. 4).  PEPPs will be offered throughout the EU by various financial firms already established in  Member States (Art. 5) that will offer PEPPs along with other products in their portfolio. Some will manufacture their own products (PEPP provider), others will act as intermediaries, sellers of products manufactured by other PEPP providers (PEPP distributor) (Art. 8).

What are the special features of PEPPs?

As part of the Capital Markets Union, PEPPs are intended to be a pan-European products. So the most important feature of PEPPs is their portability- consumers will be able to continue their contributions to their chosen PEPP even after moving their domicile to another Member States (Art. 12). Portability however is not as straight forward as it sounds at first. Given the very different national regimes across the EU especially the applicable tax incentives, PEPPs will operate as a series of national compartments, each compartment being compliant with national rules. A new compartment will be opened with every new PEPP account, that corresponds to the legal requirements and conditions for using tax incentives fixed at national level. The mechanism for opening new compartments, transferring the accumulated rights between these compartments and providing information about this option is laid down in the proposed Regulation. 

Switching is the other important feature. PEPP consumers can switch providers once every five years at a capped cost of 1.5 % of the PEPP's positive balance (Arts 46-48)

Are PEPP investments safe? 

The most important worry of with every investment is what will happen if the investment product does not perform as expected and what will happen if the provider goes bust. These questions are especially important with long term products as pensions, in which we might invest for years before we see any benefits of our investment, and on which we relay hugely as a source of income in times when we need it the most. The proposal provides for a Basic PEPP that protects at least the capital invested. This is however not the only version of the PEPP that consumers will be offered (the name of the proposal is misleading suggestions that there is only one PEPP product). Consumers will be offered up to five investment options, one of them being a default that protects at least the capital invested, from which consumers must choose. The investment choice can be changed free of charge once every five years (Arts. 34-36). Although the proposal provides for a guarantee of capital protection for the default investment option (Art. 37),  this protection does not seem to extend to other versions of PEPP. Anyone opting for a more complex or risky PEPP will not be protected.  It is also unclear what sort of guarantees are in place to protect the capital of basic PEPP.

As with every investment, the well-being of consumers is affected by the way their investments are managed. To this effect, the proposed Regulation contains basic rules on the type of acceptable investment for PEPP firms (Art. 33). 

What other rules are included into the proposed Regulation?

Similarly to other European legislation, the provisions of the current proposal are heavily weighted in favor of information rules. Transparency  is secured by electronic communication as the default (Art. 21). Prior to the conclusion of the contract, information is supplied on a PEPP key information document (KID), setting out specified standard information, building on existing rules in the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation. Importantly, KID will information on past performance over at least five years, or the maximum available (Art. 23). There are special rules on PEPP advice (Art. 25) and information communicated during the contract (Art. 27), including the PEPP Benefit Statement giving specified information on accrued entitlements or accumulated capital and any guarantees applicable (Art. 28), and information on how to access supplementary information such as information on annual accounts and annual reports of PEPP providers (Art. 29)

The role for Member State regulation?

Although the PEPP product is intended to be a pan-European product, the proposed regulation only seems to lay down some basics for the creation and sale of products leaving a large space for Member states to vary especially in the design of products. Features related to the accumulation phase such as age limits, maximum amounts of contributions and early redemption rules (Art. 40), and those related to decumulation phase such as forms of pay-outs (Arts. 51-52) are left to the discretion of Member States.

What if something goes wrong?

The proposal obliges PEPP providers and distributors to have in place adequate and effective internal complaint handling schemes (Art. 43) and Member States to have adequate out of court, alternative dispute resolution procedures in place (Art. 44).

Final thoughts

The Proposal is currently in the legislative process. It has already received substantial amendments but may be subject to more before the final shape of the text. For example, it has now been clarified that the overall costs and fees should not exceed 1% of the accumulated capital per year. Better Finance has also achieved for the proposal to provide for a special provision of collective redress for PEPP consumers. However, significant concerns remain over crucial features of the product, for example over how the capital protection will work (see here).

On a more fundamental level, I find it hard to understand: how is the PEPP a pan-European product? Apart from the possibility of portability (which I am unclear how it would work in practice and whether consumer interests are truly protected), I don't see much efforts for the creation of a pan-European product, or a a financial product for that matter. Most of the features of the product are left to be regulated by Member States- a product cannot be created by information provision! Why is there not one or let's say three kinds of standardized PEPP (if we want to give choice to consumers) that are the same everywhere in their basic product features, that are reasonable priced and safe (with adequate capital protections), and that are offered by various providers throughout the EU?

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?

New study on the distribution of retail investment products in the EU

Today the EU Commission reminded us on a study conducted by Deloitte Luxembourg on Distribution system of retail investment products across the EU published in April 2018. The study investigated how well EU retail investment markets work for consumers, covering 15 Member States. Unsurprisingly, the study concluded that although consumers have choice, they face significant challenges in collecting and processing information for making good investment choices (see the summary of findings here and the full study here).

Non-performing loans: the impact of the proposed rules on consumers

On the 14^th of March 2018 the EU Commission published its proposals for tackling the problem of non-performing loans (NPL), i.e. the Proposal on a Directive on credit services, credit purchasers and the recovery of collateral.

NPLs are loans on which borrowers are unable to make the scheduled payments for more than 90 days, or those loans that the financial firms assess as being unlikely to be repaid considering other criteria. The financial crisis made the problem of NPL particularly acute, when masses of borrowers (consumers and businesses) were unable to pay their debts. As a result, a large number of NPL piled up on the books of financial firms, tying up their capital and endangering their solvency; and depending on the size and number of firms affected potentially threatening the stability of the entire financial system. Consequently, the initiative for their regulation came under the umbrella of completing the Banking Union. The Proposal is also part of the broader effort to create a Capital Markets Union. 

The proposed Directive aims to tackle NPLs in two ways. First, it seeks to encourage the development of an EU-wide secondary markets for NPLs by establishing a harmonized legal framework for the sale of these products. Secondly, it seeks to increase the efficiency of debt recovery procedures through the availability of a distinct EU-wide common accelerated extrajudicial collateral enforcement procedure (AECE). Although the proposed Directive is not a special consumer protection instrument (it applies to both consumer and business NPL loans) consumer interest are taken into account under both pillars.

Under the first pillar, the Proposal put in place safeguards to protect consumers whose loans are being classed as NPL and are being sold to third parties. These third party buyers may be banks and non-bank institutions, and they may be based in a different Member State from the originator of the loan. This naturally raises concerns. Non-bank institutions, specialized debt collection firms are known for using unfair and harsh practices in collecting debt from consumers. Depending on the Member State, these firms may fall under a less stringent regulatory regime than banks, including looser conduct standards which they must adhere to. It also raises the danger that consumers would be subjected to a foreign legal regime if they decide to challenge the behaviour of the debt collector or if they are being sued. To prevent any harm stemming from these aspects, the Proposal clarifies that consumer protection rules that were applicable to the initial credit agreement, i.e. the agreement that consumers entered into with their banks, will continue to apply irrespective of who buys the loan and irrespective of the legal regime in force in the Member State where the loan is sold to.

The Proposal clarifies that consumer protection rules specially include the rights granted under the Mortgage Credit Directive, the Consumer Credit Directive and the Unfair Contractual Terms Directive. In the same way, all the consumer protection rules in force in the Member State of the consumer continue to apply, including statutory and other mandatory law. The legal framework seems to be understood more broadly than formal rules, including infromal procedures put in place to protect the most vulnerable, the overindebted consumers. In order to create a coherent legal framework, the new rules will ask for an amendment to the Mortgage Credit Directive. Similar to Article 17 of the Consumer Credit Directive, in the event of assignment of the creditor's rights to a third party, the Mortgage Credit Directive will be amended to state that the consumer shall be entitled to plead against the assignee any defence which was available to him/her against the original creditor.

Regarding the second pillar, consumers are protected by consumer contracts being exempted from this special enforcement regime. Consumer debt will have to be enforced by the existing enforcement procedures in Member States.

We can therefore see that the the new rules as they stand in the Proposal are not likely to have a significant effect on consumer welfare, they will neither provide more protection nor will they harm consumers. The level of consumer protection will remain the same as before the Directive: the effect of the Proposal is status quo on consumers. It is a distinct question to what extent the existing, underlying rules protect consumers, and whether this Proposal should complement or supplement the existing legal framework with more substantive intervention.

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This post is a response at a special request of one of our readers. Please let us know if you would like to hear our view on an EU consumer protection matter of a special interest to you.