Retrocession refers to the compensation accepted from third parties in association with the provision of financial services.
Distribution retrocessions embedded in fund management fees, a ‘fee-only’ model, have been a feature of European fund distribution practices for many years. Proponents argue that ‘fee-based models’ make it easier for advisers to actually generate added value for their clients because they select suitable investment solutions independently of commission incentives.
In the past several years, however, this bundling of distribution and investment management fees has become the target of increased scrutiny from legislators and regulators across Europe.
EU Financial Services Chief Initially Pushed Blanket Retrocessions Ban
The European Commission, particularly Commissioner Mairead McGuinness, has sought to establish the validity of the ‘fee-only’ model. In early 2023, McGuinness began a push for an outright ban on retrocessions in anticipation of the 2024 European Parliament election.
Some European jurisdictions have already imposed bans on retrocessions in certain circumstances, notably in the context of discretionary investment management services.
The UK industry – where funds are largely distributed by independent financial advisers, wealth managers, digital platforms, and banks – banned retrocessions in January 2013 with the introduction of the Retail Distribution Review (RDR). The Netherlands has since adopted a similar measure.
Blanket Ban Scaled Down in ‘Value for Money’ Rules Draft
EU’s executive European Commission made preparations to publish legislative proposals known as the Retail Investment Strategy in May 2023, intending to deepen involvement of small investors in capital markets, partly by using tougher protections to build up trust in investing.
In its proposal, a recast of the Markets in Financial Instruments Directive from 2019 (commonly known as MiFID 2), the European Commission backtracked on McGuinness’ initial call for a blanket ban on retrocessions, rather, the EU would not follow the lead of the UK and the Netherlands by banning inducements completely. Instead, the proposal was for a partial ban on retrocessions for ‘execution-only’ products where no advice is given.
The proposal intended to stop independent financial advisers and discretionary investment managers from receiving “inducements” or “retrocessions” from product providers, suggesting that such payments would be inconsistent with the nature of the duties owed to their clients.
Under the initial draft proposals, banks, insurers, and asset managers in the European Union would only be allowed to sell funds and other products across the bloc if they could prove to regulators they offer value for money.
The commission’s proposal echoed the UK Retail Distribution Review (RDR), which has already barred investment advisers – and more recently platforms, subject to a transitional period – from accepting retrocessions from product providers.
Pushback on Retrocessions Ban
The proposals to ban retrocessions have proved controversial across the EU.
The EFPA, the leading professional standards setting body for financial advisors and planners in Europe, claims financial advisers have a crucial role in promoting the participation of retail investors in the markets, reinforced due to the commitment of the professionals themselves to improve training in recent years, the development of a continuous training plan, and their drive to improve the levels of financial education, as the European Commission itself recognized.
While McGuinness believed a rule change could cut the cost of products, opponents, including the European Fund and Asset Management Association (Efama) came out against the reforms, arguing that banning retrocessions could drive up adviser costs and price some clients out.
Another common argument from opponents is that access to advice will be reduced if retrocessions are abolished, as they have been in the UK and the Netherlands.
European Parliament Votes to Remove Retrocessions Ban
In response to the pushback, the European Parliament voted last month to remove the partial ban on retrocessions from its Retail Investment Strategy (RIS).
It came as the European Commission had already scaled back its calls for a blanket ban on retrocessions in its proposals in May 2023, following heavy lobbying from the asset management industry and some EU states.
While the latest vote does not officially end the calls for a retrocession ban, as all EU states must formally solidify their positions before final negotiations can begin, some believe it does indeed signal the end of the most recent campaign to ban the practice.
Transparency is Key
The real issue beneath the ban proposals does not seem to be about retrocessions themselves but more about transparency.
The job of regulators is always to sift through the noise and commotion to better protect investors. Above all, it is transparency that regulation seeks to defend. The question they must answer is whether the current system is so unbalanced that it necessitates action on investors’ behalf.
With that said, it seems improbable that a retrocession ban would pass under current circumstances, with most of the industry firmly against it.
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