Inducement ban – Forewarned is forearmed

Inducements are an important revenue driver for many financial industry players. For example, under a widely used business model, investment advisors do not charge their clients a direct cost for advice but get a volume-based distribution fee from the manufacturer of the product that they advise to their clients (such as an investment fund).  

This practice is allowed under quite strict conditions set by Directive 2014/65/EU on markets in financial instruments (or “MiFID II”), but remains under discussion due to the inherent conflict of interest which opponents argue it creates.

Recently, the pressure at the European level against inducements has been ramping up again. The three EU actors are involved in the discussion: Parliament, Council and Commission. 

In October 2022, several members of the European Parliament have proposed amendments to MiFID II to introduce an almost complete ban on inducements including for investment advice and execution-only services.[1] It was known that “payment for order flow” was subject to intense scrutiny. However, the fact that the net would be cast wider is a small – but not completely unexpected – surprise. Still, the positions of the different fractions of the Parliament on this topic is not entirely clear.[2]

At this point, the negotiators on behalf of the Council appear not (yet) to have a mandate to agree on a full ban on inducements. On 20 December 2022, the Council issued a press release which only mentions a soft payment for order flow ban.[3] This is not really a surprise given the strong opposition of Germany against a full inducement ban.[4]

The strongest advocate of a full ban appears to be the Commission. In a letter of 21 December 2022 to MEP Markus Ferber, Commissioner Mairead McGuinness quite vigorously defends an almost full ban on inducements as the only solution to protect retail investors[5]. On 24 January, Commissioner McGuinness defended this position in the Committee on Economic and Monetary Affairs of the European Parliament but surprisingly hinted that there was a small likelihood that the Commission would stop short of proposing a full ban and only advocate for stricter transparency.[6]

In the coming months, it is expected that the Council, the EU Parliament and the Commission will take further position while they also might have informal so-called “trialogue” meetings to align and negotiate a common position. Commissioner McGuinness announced in the Committee on Economic and Monetary Affairs that, by April, the Commission would anyhow publish new proposals to mitigate this conflict Whatever the outcome, a final decision will have a high likelihood of being replicated for insurance-based investment products under the Insurance Distribution Directive (“IDD”).

A full ban would involve a far-reaching change of the current inducement rules. Currently, non-independent investment advice and execution-only services inducements are allowed provided that :

• the inducement results in quality enhancement of the services provided (“quality enhancement test”),
• it does not cause a conflict of interest, and
• received or paid inducements are disclosed to the client.

The potential ban would have a major influence on the remuneration model of non-independent advisory and execution-only services. In Belgium, where the bank-centric distribution model is more prevalent and where inducements from third parties are still a major revenue source, the impact would be significant. In many countries, retail investors are not accustomed to paying an upfront fee for investment advice. It remains to be seen whether they are willing to do so in case a ban would close the inducements revenue stream.

A ban is far from certain in the short run. However, given the very material impact, many financial players are reviewing alternative scenarios in case of an inducement ban, which is by some viewed as inevitable in the long run.