ESMA seeks input on retail investor protection and PFOF

The European Securities and Markets Authority (ESMA) today published a call for evidence on a number of retail investor protection topics under MiFID II.

The regulator notes the retail investment frenzy relating to certain stocks that was observed in January and February this year (‘GameStop case’) which has raised concerns around the provision of execution only and brokerage services via online platforms and has highlighted specific risks connected to some emerging business models.

The business models of “zero-commission brokers” and the practices of “payment for order flow” (PFOF) have been thrusted in the limelight. In July 2021, ESMA issued a statement to warn firms and investors about risks arising from payment for order flow.

In that statement, ESMA said that “the receipt of payment for order flow (PFOF) touches upon a number of key MiFID II obligations aimed at ensuring that they act in their clients’ best interest when executing their orders. In light of the serious investor protection concerns raised by PFOF and the multiple requirements applying to it, it is in most cases unlikely that the receipt of PFOF by firms from third parties would be compatible with MiFID II and its delegated acts”.

The statement outlines a number of investor protection concerns raised by PFOF connected to the requirements on conflict of interest, best execution, inducements, and cost transparency. Specific concerns regarding certain practices by “zero-commission brokers” are also highlighted in the statement.

ESMA requested national regulators to prioritise PFOF in their supervisory activities for 2021 or early 2022, especially in those Member States in which PFOF has been observed. In the context of this call for evidence, ESMA now looks forward to any useful input from stakeholders on the need to adapt the current legislative framework to address these investor protection concerns.

The practice of PFOF is not the only concern that arises with some online brokers. Other concerns include the broad availability of risky and complex products, margin trading with such products, the use of gamification elements to steer clients to trade these products or to trade too often and misleading marketing communications.

ESMA asks whether any changes should be made to MiFID II (e.g., suitability or appropriateness requirements) to adequately protect inexperienced investors accessing financial markets through execution only and brokerage services via online platforms.

The EU securities markets watchdog also asks whether the public considers that the current regular framework sufficiently protects retail investors against the risks of margin trading, especially the ones that cannot bear the risks.

Other questions include:

• Are you familiar with the practices of payment for order flow (PFOF)?
• Have you observed the practice of payment for order flow (PFOF) in your market, either from local and/or from cross border market participants? How widespread is this practice?
• Do you consider that there are further aspects, in addition to the investor protection concerns outlined in the ESMA statement with regards to PFOF, that the Commission and/or ESMA should consider and address?

In addition to the above, the ‘GameStop’ case has also raised concerns around the use of social media as a source of information on which retail clients base their investment decisions. In this context, in February 2021 ESMA issued a statement urging retail investors to be careful when taking investment decisions based exclusively on information from social media and other unregulated online platforms, if they cannot verify the reliability and quality of that information. As part of this call for evidence, ESMA welcomes any useful input on the impact on retail investors` behaviour of information shared on social media.

The list includes questions such as:

• Do you observe an increasing reliance of retail clients on information shared on social media (including any information shared by influencers) to base their investment decisions? Please explain and, if possible, provide details and examples. Do those improve or hamper the decision-making process for clients?
• What are, in your opinion, the risks and benefits connected to the use of social media as part of the investment process and are there specific changes that should be introduced in the regulatory framework to address this new trend?
• Are you aware of the practices by which investment firms outsource marketing campaigns to online platform providers/agencies that execute social media marketing for them, and do you know how the quality of such campaign is being safeguarded?
• Do you have any evidence that the use of social media (including copy/mirror trading) has facilitated the spreading of misleading information about financial products and/or investment strategies?

The call for evidence is open until January 2, 2022 and seeks feedback from all interested stakeholders. Due to its focus on investor protection issues, the paper is addressed to investors and consumer organisations, to investment firms and credit institutions performing investment services and activities and to manufacturers of PRIIPs, and to any relevant trade association.