The International Organization of Securities Commissions (IOSCO) issued a report with some remarkable findings. Given its mission to assist regulators in responding to the retail market conduct issues caused by stress events such as the current COVID-19 pandemic, the report examines common retail misconduct risks that have arisen in the financial services industry during the pandemic and sets out measures to assist authorities in responding to this unprecedented and challenging environment.
The conclusions are based on preliminary findings and observations of IOSCO member experiences. Common drivers of firm and retail investor behaviour are identified. IOSCO believes that these drivers together create increased opportunities for potential misconduct in periods of stress.
The COVID-19 crisis impacted firm and retail investor behaviour by extreme price volatility during March-April 2020 and the growing pressure of COVID-19 on firms’ profitability. This may have resulted in increased offerings of riskier products and retail investor flow into such products, says IOSCO: “The COVID-19 experience also highlights that retail investor vulnerability may take many forms and vulnerable investors may be more susceptible to financial exploitation during periods of market stress.”
Risk profiling aims to identify a client’s level of required return, and therefore risk, to meet their investment objectives; their risk capacity and; their tolerance to risk. Some statements in the IOSCO report call for deeper knowledge about the risk profiles of investors: “Worsening economic outlook as a result of lockdowns and accentuated by higher volatility can create competitive pressure on firms to survive or sustain revenue levels. When commissions fall and firms begin to struggle with profitability or when volatility increases and retail investors seek out or are lured into investing in volatile markets to make profit, firms may start offering riskier products outside investors’ risk appetite that can result in potential investor harm.”
Psychological studies show that investors’ risk appetite is relatively stable. The attitude of adult investors to risks in their financial investments is relatively stable. Risk profiling is a process that financial advisors use to help determine the optimal levels of investment risk for clients.
Whether IOSCO’s findings demonstrate a spectrum of retail misconduct ranging from the more egregious examples of fraudulent or predatory practices by unlicensed operators to incidents of inadvertent misconduct by regulated entities, still has to be supported by further evidence. Undoubtedly, common types of potentially harmful behaviour that may increase during periods of stress include mis-selling; mis-labelling; and misleading disclosure and investment advice.
Based on its review of the case studies, IOSCO suggests a number of measures that regulators can take in responding to the challenges created by the COVID-19 pandemic.