Retail investment product reform

Investment advisers are confronted with a major dilemma when dealing with clients. When they recommend a financial product that goes on generating a positive return, clients will not thank them – investors take that positive return for granted and think that advisers do not deserve anything as it is, after all, their job to provide good advice.

On the other hand, when the recommended financial product generates bad returns, investment advisers will, at least, face the wrath of their clients but more often face a lawsuit. Furthermore, the investment adviser’s job is made even more difficult as clients typically want financial products that generate high returns but are also low risk and any standard finance textbook will tell you that there is no such thing as a free lunch, i.e. on average you can only achieve higher returns by taking on more risk.

To make it even more difficult, the current investment environment is such that many traditional retail investment products are yielding almost zero returns if not negative real returns. As a result, given that investment advisers are always treading a fine line, it is not surprising that retail investment mis-selling scandals happen. And they will continue to take place in the foreseeable future.

It is not only Malta that is confronted with this problem as the mis-selling of investment products has also taken place in other major developed financial markets. As a result, several countries have embarked on reforms or reviews that aim to address these problems. The institutions embarking on such endeavours did not have investment advisers in mind but more particularly the protection of small retail investors. These efforts were initiated as a result of some of the biggest retail investment scandals, including the payment protection insurance mis-selling which led to the largest industry settlement in the UK’s financial services history.

Malta recently experienced its own largest retail investment scandal. It is about time that Malta too embarks on a reform exercise and tries to move forward. In doing so, we do not need to start from scratch as we can take inspiration from similar initiatives taken abroad, more particularly the UK, over the last few years. The initiatives should tackle three groups: clients, the investment advisors and financial products.

First, educating potential investors about basic concepts will help to induce investors to reduce their investment expectations to more realistic levels. The MFSA has taken several initiatives aimed at the consumer and has a section of its website dedicated to these issues. The MFSA’s website could try to emulate other websites in English which are more complete and user-friendly. Most of the conclusions of the Thoresen review on generic financial advice would also be valid for Malta, notably the setting up of a service similar to the Money Advice Service. Another commendable initiative taken recently by the Government is the establishment of a Commission for Financial Literacy which will be embarking on a national survey followed by the formulation of a national strategy.

Hopefully this will induce the investment public to ask the right questions to their investment advisers and be in a position to better judge the quality of the financial products that are offered to them.

Secondly, the UK recently reformed the way investment advisers work and more importantly the way they are remunerated. Following the Retail Distribution Review which will enter into force on January 1, investment advisers will now be paid on a consultation basis and not through a commission paid by the promoter of the investment product any longer.

This will go a long way towards eliminating potential conflicts of interest. It is still too early to evaluate the effectiveness of such a reform but it should render the investment process more transparent and ensure that the interests of the retail investors are safeguarded.

Thirdly, the Sergeant Review is currently working with all the relevant stakeholders on offering customers simple financial products. The outcome should be the introduction of a suite of simple, easy-to-compare products which should lead to restoring trust in the industry and encourage more consumers to enter the financial services market and take decisions about their finances with confidence.

Finally, the UK has also undertaken changes within the financial services regulator. Most notably, a Financial Conduct Authority has been set up with the main purpose of monitoring the behaviour of financial institutions and ensuring that consumers are provided with robust, fair, and proportionate protection.

Given Malta’s own recent retail-related scandals, we, more particularly the MFSA, could initiate a similar consultation process and take some of these suggestions on board and explore whether these could be implemented locally. Implementing some, if not all, of these ideas would go a long way towards improving the situation of small retail investors.

Robert Suban is a full-time academic within the Department of Banking and Finance at the University of Malta.