Mis-Selling Incentives: European Regulators Finally Crack Down on Sales Staff Pay Structures

Martin Wheatley, managing director of the FSA and future head of the UK Financial Conduct Authority, announced this week the results of a disheartening review of incentives schemes  for sales staff at financial firms (banks, insurance companies, and investment advisory firms). At the 22 firms surveyed, most incentive schemes were likely to lead to mis-selling, and the risks were not properly managed. Some of the examples mentioned seem clearly incompatible with appropriate management of conflicts of interest.

The FSA’s actions follow a spate of mis-selling scandals in the UK, most recently regarding sales to retail investors of Payment Protection Insurance (PPI) and of interest rate swaps to small and medium-size companies.

As a result of the review, the FSA has also launched a consultation on new rules regarding sales staff compensation and related governance and controls, although financial firms are already now supposed to review their incentive schemes, modifying them if necessary.

Action by the FSA is certainly due to the recent scandals (including the LIBOR manipulation one), but public outrage at bank behavior and remuneration has been mounting since the financial crisis and the bailout of major UK banks by taxpayers. Years ago, the FSA started initiatives aimed at treating customers fairly, and followed later with the Retail Distribution Review (RDR) which outlawed the payment of retrocessions by product providers to distributors and imposed the fee-based advice model on the UK market. They are also proponents of stronger intervention by regulators in product structures and manufacturing. Nonetheless, it has become clear that without direct intervention and stricter regulation of remuneration structures, retail clients’ interests may continue to be neglected by staff at financial institutions due to the wrong remuneration incentives. The culture of financial institutions has not been sufficiently changed by the crisis, and strong, direct intervention is the only way to restore the trust of investors.

The UK regulator is not the only one trying to address mis-selling and unsuitable investment advice. A heated discussion is ongoing at the European level on the revision of the Markets in Financial Instruments Directive (MiFID), which covers the distribution of many financial products (except pure banking products and insurance products), and regulates the remuneration for advice and portfolio management services and client disclosure. The French regulator, the Autorité des marchés financiers (AMF) has recently also consulted on the need to tighten rules on the remuneration of financial product distributors and to enhance disclosure to clients. Other national regulators in the EU (in Italy, the Netherlands, Denmark) have already implemented or plan to introduce restrictive regulation, but on a much more limited basis. In part, this is due to the fragmentation of EU regulation of financial product distribution which is not helping regulators and does not reflect either the prevalence of financial bank-insurance conglomerates (particularly in Continental Europe), or the multiple types of distribution channels for each product.

Unfortunately, the focus has so far been too narrowly limited to MiFID’s payments from product producers to distributors or — in the case of banking remuneration — to the remuneration of top management and risk-taking personnel such as traders. MiFID’s principles are good, but they are high level and do not cover in detail internal remuneration structures; implementation has been patchy and sometimes not strict enough, particularly the enforcement of retail investor protection rules. Remuneration rules for top management and traders in the banking industry do not affect sales staff.

It is time to shine light on remuneration practices for the staff involved in sales to retail clients: less exciting perhaps than the remuneration of bank CEOs, but just as important in terms of impact on investors and bank clients in general. It remains to be seen whether the FSA initiative will be successful in providing the right motivation, and whether it can be adapted to other regulatory environments. However, it is a positive first step towards improving investor protection and the internal culture of financial firms, the two key elements needed to restore faith in the financial industry.