The Bank of Russia has recently updated its Basic standard for protection of investors’ rights. The key novel is that to transact on certain financial instruments, unqualified investors should pass a test.
The policy behind the testing is, as I see it, to make it harder for ‘newborn’ retail investors to make deals in cases when investors might not fully understand the nature of the transaction at question, might undertake exorbitant risks, and — as a result — might suffer from significant financial losses.
Both the investor and the financial market are supposed to ultimately benefit from test barriers as long as no one is interested in growing number of dissatisfied, financially broken investors who have lost confidence in the market, partially due to ill expertise and risk ignorance.
The questions the Basic standard provides consist of two blocks — Self-Assessment and Knowledge.
The Self-Assessment bloc requires investors to recall for how long, how often and what deals they have made.
The next one, the Knowledge bloc, is instrument-specific. For example, to deal with foreign ETFs, the one should know how is the ETF price formed, what are the risks of investing in foreign ETFs, and what are the relevant tax consequences.
What worries me in this regard is not what is written, but what is not.
Here I share a couple of points that concern me a lot.
First, about subject matter of investors’ knowledge.
I suppose, when you enter any industry, you need first to understand the parameters of the industry you are dealing with.
Who are the players? Who are the winners? Who are the losers? Whose loss is your gain and vise versa? How is the industry set up? What parameters can you operate? Whether and how can you succeed? What mistakes should be avoided? Etc.
Contrary to this logic, the Basic standard has no intention to test the investor’s knowledge of the financial industry.
Basically this allows the deals made by investors who know, let’s say, what is ETF, but have no clue how the market functions.
To invest prudently, it is reasonable to understand how the market works and that conflicts of interest exist. The current testing framework appears to disregard this point.
Second, about education.
The Basic standard covers educational matters in the following two aspects — the broker should send a notice to its client who is about to deal with certain risky instruments, and the broker should educate its employees.
But the Basic standard appears to pay little to no attention to the way brokers educate their clients.
In practice, brokers should be incentivized by volume and frequency. They would prefer their clients to trade at the biggest size possible as frequent as possible. (In all fairness, positive financial results of trading also matter.)
In such context, it is not surprising that brokers might be willing to make their clients believe, for example, in short term trading, leverage trading, or wallstreetbets-like trading.
Educating how to, figuratively speaking, press a button as much as possible might benefits brokers, but explores — and, ultimately, destroys — the retail investor’s belief in the market. Proactive regulatory reaction to prevent such malpractices is needed.
Disclaimer: This is my personal blog. This is neither a legal opinion nor a piece of legal advice. The opinions I express in this blog are mine, and do not reflect opinions of any third party, including employers. My blog is not an investment advice. I do not intend to malign or discriminate anyone. I reserve the right to rethink and amend the blog at any time, for any or no reason, without notice.
