Views on improving the integrity of global capital markets
26 July 2021

Improving Investor Protection and Business Conduct in Covid Times: Can Industry and Regulators Work Together to Enhance Trust in Capital Markets?

Just like the 2008 global financial crisis, the Covid-19 pandemic has led to the proliferation of several business conduct issues, which have been negatively affecting investor trust in financial markets. Restoring confidence is a precondition for a swift recovery from the current crisis. Day two of the CFA Institute Financial Regulatory Symposium 2021 featured an in-depth discussion on these themes, and the measures that regulators can put in place to encourage ethical behavior.

Paul Andrews, managing director, Research, Advocacy, and Standards, CFA Institute, gave the keynote speech. Andrews cited the CFA Institute 2020 “Earning Investors’ Trust” survey report, which shows that 67% of global investors, who do not have a financial adviser, believe that markets are not fair and effective. This is a concerning number, and it explains why regulators, businesses, and industry professionals should work together on issues related to business conduct, investor protection, financial education, and inclusion.

An important issue that Covid-19 made more evident is the practice of gamification of financial markets. Andrews stressed that new active investors are attracted to this way of investing, which uses an appeal akin to that of video games to facilitate and incentivize trading. These individuals, who often are uninformed and unaware, are subject to greater potential risks than investors benefiting from sufficient financial literacy.

The speech was followed by a panel discussion with securities markets regulators from Australia, the United States, the Netherlands, and Portugal. Cathie Armour, commissioner, Australian Securities and Investment Commission (ASIC), remarked on the significant increase in retail investments and on the growing interest in riskier products in Australia, which have been observed in the past few years. When coupled with rapid digitalization, both have created fertile ground for an increasing number of financial scams, mostly related to cyber assets. Warnings are a quick way for regulators to act and send a message to individuals, but their efficacy is limited. Regulators should directly intervene by preventing the marketing of high-risk products, such as binary options, into retail markets or should put conditions on certain products that are made available to retail investors.

Allison Herren Lee, commissioner, US Securities and Exchange Commission (SEC), highlighted that the SEC recently issued a regulatory agenda that includes potential rules related to gamification practices, with behavioral prompts, and thorough predictive analytics. Technology developments have raised several policy questions, such as whether online platforms and apps incentivize excessive trading, and whether they encourage investments in products that are not aligned with their client’s investment objectives. The SEC has been examining these issues.

The challenge for regulators is to strike the right balance in the triangle consisting of product governance, fiduciary duty, and investor education. Balancing these three elements would allow retail investors to invest in products as long as risks are clearly disclosed to the end investor, who must have a clear understanding of the proposed risk–return trade-off. Laura van Geest, chair, Executive Board of the Dutch Authority for the Financial Markets (AFM), explained that the AFM expects firms to use behavioral insights when they determine their distribution channels. Businesses should have a clear idea of their target audience and then ensure that their marketing and distribution efforts are properly aligned. In addition, the AFM looks at business incentives and whether these encourage unethical conduct. The AFM carries out research and investigations within firms and then gives the results to these businesses so that they can make the necessary changes.

Rui Pinto, member, Board of the Portuguese Securities Market Commission (CMVM), focused on the best ways to improve ethical behavior within organizations. This effort depends on people’s adequacy, competence, ethics, and honesty. People shape their organization’s business conduct. Companies, however, also should build up a strong and robust internal control environment to have adequate risk management, compliance, and internal audit functions. Pinto also underlined that some incentives, including forms of remuneration, that are given to salespeople could give rise to unintended consequences regarding the suitability of products in the sales or advice process. The Markets in Financial Instruments Directive (MiFID II) requires strict requirements for people who want to provide investment advice (knowledge and competence rules). Unfortunately, MiFID II rules do not refer to ethics training for professionals providing investment advice. Training would be key to develop investment advisers’ ethical thinking.

The CFA Institute “Covid-19, One Year Later: Capital Markets Entering Uncharted Waters” report highlights that regulators in advanced economies have adequately addressed the crisis, according to a global survey of CFA Institute members. They now, however, are expected to put in place measures to reinforce investor protection and address issues related to inappropriate ethical behavior. Improving individuals’ financial literacy and preventing mis-selling cases and market abuses are necessary steps to rebuild investor trust in capital markets.

You can watch the webinar here: https://www.cfainstitute.org/research/multimedia/2021/financial-regulatory-symposium-2021?s_cid=smo_EMEASAdv_OF_LI.


Photo Credit @ Getty Images / Nikolay Pandev

About the Author(s)
Roberto Silvestri

Roberto Silvestri is EU Policy Specialist, Capital Markets Policy EMEA at CFA Institute. He helps reach out to regulators and stakeholders about the positions that CFA Institute holds and unravel the complexities of EU regulation for CFA Institute members.

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