Pursuant to the market practice in France, distributors – such as investment service providers or financial advisors – are not paid directly by investors but rather receive a rebate or inducements from the issuer of the financial instrument (e.g., the manager of the fund when dealing with UCIs). This practice raises potential conflict of interest issues, as distributors might offer advice favoring investments in a product because of the rebates to be received and not due to the inherent features of the product at hand.
In an effort to deal with this potential conflict, and further to the implementation of MiFID in 2007, the Autorité des Marchés Financiers (“AMF”) issued a set of rules regarding transparency requirements for remuneration, rebates and inducements in the course of the marketing of financial instruments (“Remuneration Rules”).1 Following a public consultation by the AMF in 2012 regarding the application of the Remuneration Rules, the AMF issued a position and recommendation paper on 10 July 2013 (“AMF Paper”)2 with a view to providing guidance and to address practices that the AMF deemed non-compliant with the Remuneration Rules.
Both the 2012 public consultation and the AMF Paper were intended to better enable the AMF to monitor how the Remuneration Rules were being followed and responded to the results of a survey conducted by the AMF in 2011.3 The results of the survey indicated that the percentage of distributors then in compliance with the Remuneration Rules was quite low. Since such non-compliance might have stemmed from a lack of AMF guidance when the Regulation Rules were first implemented, the AMF felt it necessary to issue additional clarification to remove any remaining uncertainty, with the expectation that the relevant entities would then fully comply with the Remuneration Rules.4
The AMF Paper addresses the following key areas: internal systems and procedures for the identification and classification of remuneration and benefits; disclosure to investors; and enhancements to the quality of customer service and the need to act in the best interest of investors.
Internal Systems and Procedures for the Identification of Rebates and Inducements
Finding: The results of the 2011 AMF survey indicated that only a minority of respondents had established procedures dedicated to the treatment of rebates and inducements and, in most cases, these were limited to a mere accounting check to ensure that payments had been made to distributors within the framework of respondents’ existing agreements.
AMF position: Accounting checks alone are not sufficient. Each distributor must be in a position to provide the AMF with evidence of a thorough identification and classification of the various types of inducements and rebates received, paid or offered in relation to the provision of an investment service (or an ancillary service), as well as an analysis of whether the inducements and rebates conform with the Remuneration Rules.
AMF position: When several professionals are part of the distribution process, the Remuneration Rules apply only to the professional providing the service to the end-client.
Disclosure to Investors Regarding Rebates and Inducements Received from or Paid to Distributors
Quality of the Information
Finding: Depending on the financial instrument in question (e.g., share/unit of UCIs, structured debt instrument), the quality of information delivered to investors is quite variable; however, in most cases, the quality of the information delivered could be improved.
AMF position: When distributors provide investors with summary information regarding ranges of fees per category of products, such categories must comprise a consistent economic whole. The ranges must further be reasonable and should not exceed approximately 10 percent of the management fees.
AMF recommendations: Distributors of UCIs should present information in such a manner that investors receive at one time all of the information related to rebates and inducements received by the distributor. Also, when reference is made to percentages of the management fee, such management fees should be communicated. For communication via the internet, a good practice would be to associate the process of selling funds with the delivery of the relevant documents (e.g. the KIID) that include the required information on rebates and management fees. For face-to-face sales, a good practice would be for the account executive to inform the investor of such rebates and management fees and to ensure that the KIID given to the investor contains a reference to such fees.
Timing of Delivery of the Information
Finding: In about one-half of instances, information regarding rebates and inducements paid to third parties is provided to investors only at the time they initially enter into the relationship with the distributor – either in the documentation signed by the investors or in the fee schedules.
AMF Position: Communication of information regarding such rebates and inducements only at the time of the entering into the relationship (and not subsequently) is considered to be sufficient only for portfolio management services (as such services are inherently regarded as ongoing in nature). Otherwise, such information must be furnished prior to each service provided (unless such service is of the same nature and concerns the same type of instrument as a prior service performed recently).
AMF Position: Remuneration and inducements paid by a management company in relation to portfolio mandates entered into prior to 2007 (i.e., before the Remuneration Rules) must be disclosed – there is no ability to “grandfather” the absence of such disclosure.
Finding: Some professionals use their websites to a limited extent – for instance, only to communicate information regarding inducements – although the professional’s customary relationship with clients does not involve internet communications. The AMF also noted situations where information is provided in fee schedules but the professional has not established internal procedures to ensure that such fee schedules are provided to clients prior to the performance of the services in question.
AMF position: Information on rebates must be “given” to investors and not only be “at the disposal” of investors. Information posted on the internet is appropriate, provided that this is the usual medium used when dealing with the investor and further provided that the investor must view the information on rebates, via the chaining of screens, during the process of placing orders on the website. When dealing by telephone with a client who has not signed a subscription form, the mere direction to a website is not sufficient. Detailed (or range of) rates may be given by telephone on a recorded line, or via a written medium such as an email. In all instances, the relevant KIID must be provided.
AMF recommendation: With respect to UCIs, it is recommended that the rebates received by distributors be specified in the subscription form. This would ensure that the client receives the information prior to making an investment.
Information on Entire Range of Products Proposed
Finding: Several respondents indicated that investors do not expect to receive information about the full range of products proposed.
AMF recommendations: A comparative approach would provide investors with resources to understand ways in which the distributor could be prompted to recommend that the investor act in a certain manner. The communication of detailed information on the advised product should be combined with summary information relating to rebates received by the distributor from third parties with respect to the entire range of comparable financial instruments provided by the distributor.
Enhancement of the Quality of Customer Service and Acting in the Best Interests of Clients
Finding: The French market practice is for distributors to be compensated for the provision of investment services (e.g., financial advice, receipt and transmission of orders (RTO)) via a rebate from the issuer of the relevant financial product (i.e., the manager of the fund when dealing with UCIs) of a portion of the fees received by the issuer. A distinction may be made between rebates of up-front fees (subscription fees) and rebates of ongoing fees (management fees). The AMF survey did not note specific issues with respect to rebates of up-front fees; however, it appears that transparency should be improved as to rebates received on an ongoing basis.
AMF position: Rebates received on an ongoing basis for the provision of financial advice after a client has purchased the relevant product is permitted, provided that this is accompanied by regular contact (at least once a year) with the client to ensure the adequacy over time of the products advised and that the client’s profile has not changed, or that such rebates are associated with additional services provided to the client during the relationship with the client.
AMF recommendation: A distributor that provides financial advice should establish an alert mechanism in order to detect possible changes to client profiles and resulting consequences regarding appropriateness of the products advised.
AMF position: Ongoing rebates related to closed-ended funds are permitted, provided that these are viewed (and communicated to clients) as payment in installments of a single rebate, linked to the original subscription.
AMF position: A rebate mechanism based on successive thresholds linked to the number of shares subscribed for by investors (such as a ratchet mechanism) will be assumed to not be in the best interest of the client.
Further Steps Following Review of MiFID
It is worth noting that the AMF Paper is subject to significant changes following the current review of MiFID.5 As described above, French regulations allow distributors to receive rebates from issuers of financial products such as UCIs, such rebates stemming from the fees received by the issuer from investors. However, this practice is not in line with the current review of MiFID, which envisions restricting (or banning altogether) the payment of rebates to distributors that are supposed to provide investment advice on an independent basis.
The author would like to thank Yann Le Garrec for his contributions to this article