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Law Institute
Behavioural Findings and Financial Market Regulation
AIIFL, Hong Kong February 2, 2015
Prof. Dr. Rolf H. Weber
Chair Professor, Law Faculty, University of Zurich
Visiting Professor, Law Faculty, University of Hong Kong
Law Institute
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 2
suitability
heuristics and biases e.g. loss aversion
Client
ban vs.disclosure
conflicts of interestse.g. retrocessions
Advisor
prospectusregulation
advertising vs. disclosuree.g. past performance
Producer
Potential causes of misconductPotential causes of misconduct
Law Institute
3
Often no focus on maximizing profits
Behavioural researchBehavioural research
Decisions influenced by emotions
Past performance orientation (immoderate expectations)
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber
Law Institute
Absoluterationalbehaviour
Utility maximization
Perfectinformation
Stablepreferences
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 4
Homo oeconomicusHomo oeconomicus
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5
Rational choice challengesRational choice challenges
Behaviour of a homo oeconomicus
Efficient market hypothesis
Limits of rationality assumption
Emotion, inertia, reference biases,overconfidence
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber
Law Institute
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 6
probability misjudgement
selective perception
herding
Perception
cognitive
emotional
anchoringmental accounting
overconfidence
reflection effect
Processing& validation
self-attributionhindsight bias
endowment effectsoptimism bias
Decision
Law Institute
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 7
Law Institute
European perspectiveEuropean perspective
MiFID I and II
ESMA
Implementation of systems and controls
Effectiveness and importance of the compliance function
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 8
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MiFID I and IIMiFID I and II
Appropriateness & suitability test
MiFID I
Transparency (executed documentation)
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber
Risk tolerance
MiFID II
Mitigation of conflicts of interest
Law Institute
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 10
MiFID Guidelines 06/07/2012MiFID Guidelines 06/07/2012
Greater convergence in the interpretation + supervision
Investment firms must obtain the necessary information to be able to understand the essential facts about the client in order to assess the suitability of any investment for that client (client’s investment objectives, financial situation, knowledge, experience)
Assessment:Is the specific transaction suitable ?
Law Institute
(82): When providing investment advice, the investment firm should specifyin a written statement on suitability how the advice given meets thepreferences, needs and other characteristics of the retail client. […]
Art. 25 (2):When providing investment advice or portfolio management the investment firm shall obtain the necessary information regarding the client's or potential client's knowledge and experience in the investment field relevant to the specific type of product or service, that person’s financial situation including his ability to bear losses, and his investment objectives including his risk tolerance so as to enable the firm to recommend to the client or potential client the investment services and financial instruments that are suitable for him and, in particular, are in accordance with his risk tolerance and ability to bear losses
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 11
MiFID IIMiFID II
Law Institute
(77): To further protect consumers, it is also appropriate to ensure investmentfirms do not remunerate or assess the performance of their own staff in away that conflicts with the firm's duty to act in the best interests of theirclients, for example through remuneration, sales targets or otherwise whichprovide an incentive for recommending or selling a particular financialinstrument when another product may better meet the client’s needs.
Art. 24 (10):An investment firm which provides investment services to clients shall ensure that it does not remunerate or assess the performance of its staff in a way that conflicts with its duty to act in the best interests of its clients. In particular, it shall not make any arrangement by way of remuneration, sales targets or otherwise that could provide an incentive to its staff to recommend a particular financial instrument to a retail client when the investment firm could offer a different financial instrument which would better meet that client’s needs.
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 12
MiFID IIMiFID II
Law Institute
(104) The financial crisis has shown limits in the ability of non-retailclients to appreciate the risk of their investments. While it should beconfirmed that conduct of business rules should be enforced inrespect of those investors most in need of protection, it isappropriate to better calibrate the requirements applicable todifferent categories of clients. […]
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 13
MiFID IIMiFID II
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14
Specific regulatory elementsSpecific regulatory elements
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber
Experience and knowledge
Risk absorbing capacity
Investment objectives
Law Institute
Experience and knowledgeExperience and knowledge
• Product experience
• Transaction experience
• Education
• Profession
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 15
Law Institute
Risk absorbing capacityRisk absorbing capacity
• Source and extent of income
• Liquid assets, investments
• Real property
• Financial commitments
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 16
Law Institute
Investment objectivesInvestment objectives
• Investment period
• Risk preferences
• Risk profile
• Investment purpose
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 17
Law Institute
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 18
ESMA findingsESMA findings
Failure to ask clients the right questions
Failure to recommend a suitable investment
Failure to collect the necessary and relevant information
Failure to interpret correctly the information provided by the client
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19
Risk assessmentRisk assessment
Embracement of risk preferences
Methods for risk assessment
Approaches to risk assessment
Restrictions and limitations
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber
Law Institute
Regulatory approaches in Hong KongRegulatory approaches in Hong Kong
HKMA Circular 12 Jun 2012
SFC Code of Conduct 5.2
SFC Q & A on suitability obligations
Internal study
SFC Consultation Conclusions 5 Sep 2014
New Clause in clients agreements
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 20
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21
Perform a mandatory suitability test
Combat conflicts of interests
Optimize the documentation for financial products
Code of conductCode of conduct
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber
Law Institute
2 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber 22
Limits to investor protectionLimits to investor protection
Law Institute
232 February 2015 Behavioural Findings and Financial Market Regulation. Prof. Dr. Rolf H. Weber
OutlookOutlook
Need of considering behavioural findings
Biases require more than disclosures
Hard law versus soft law