IOSCO’s retail report: future developments in supervising online marketing/selling to retail investors

On 30 March 2023, IOSCO published a final report analysing retail trends and potential sources of investor harm and proposing a series of measures for regulators to consider to address market conduct issues. The report provides insights on how regulators may develop their approaches to supervising marketing/selling activity to retail investors that occurs (i) online; and (ii) cross border.

Key trends flagged by IOSCO

Retail investor participation in capital markets has increased significantly and is expected to further increase (e.g. in the US, retail investors’ share in trading volume has increased from roughly 10% of all U.S. equities traded (pre-COVID 19 pandemic) to 20% in 2020, and 26% in January 2021). In terms of asset classes, IOSCO reports a particular rise in popularity of ETFs (e.g. in the case of US-listed ETFs, annual inflows were 55% higher in 2020 than in 2019), UCITS, equities and government bonds, as well as riskier investments (particularly with younger investors) such as OTC leveraged products (e.g. CFDs), crypto-assets and FX products.

IOSCO’s report identifies numerous interlinking reasons for the increase in retail trading and popularity of riskier products (e.g. the COVID-19 pandemic and macro-economic conditions such as low interest rates and rising inflation). However, one reason in particular stands out as transformative of the retail trading landscape - technology.

Technological developments are a “game changer"*...

• …in enhancing access for retail investors: online trading platforms, mobile investment apps and social media have made trading and stock markets more easily accessible to retail investors (e.g. in Hong Kong, 82% of investors have switched to digital platforms and in Japan, the JFSA reported that online trading securities accounts increased from 30 million to 33 million between March 2020-March 2021);
   
• …in allowing firms to interact with retail investors in new ways, e.g.:
  • registered broker-dealers and investment advisers now regularly utilise social channels such as Instagram and Twitter to market their products/services. Through social media, firms are able to engage with retail investors on their level and in ways more likely to resonate with that audience (especially younger investors) than traditional marketing methods, including by using “finfluencers”.
  • Some firms are using “digital engagement practices” including to ‘gamify’ the trading experience to increase usage and influence trading behaviour.
     
• …in changing how retail investors interact with capital markets and the products they invest in, e.g.:
  • the increasing use of mobile apps/online platforms and influence of social media are among the core reasons for an increase in levels and volumes of “self-directed trading” and move away from financial intermediaries.
  • Digital platforms/social media may also impact the type of financial products invested in by encouraging investors towards riskier products. Social media may be particularly influential in the area of cryto-assets. Retail investors lack access to professional advice on such investments (e.g. because of a lack of developed regulatory framework in some jurisdictions and unwillingness of authorised investment advisers to provide such advice) leading such investors to rely on other information channels.

Marketing/selling digitally can have major benefits...

While not the focus of the report, IOSCO notes that marketing/selling via digital means can have benefits, for example:

• online trading platforms and social media can make investing more accessible and engaging. For example, even gamification techniques may be helpful in conveying complex information in a simple and rewarding way.
• Such channels can also be used to reduce information asymmetries. IOSCO notes that the use of social media by registered entities, if done responsibly, has the potential to provide important information to investors that access these channels.
• New technologies have also led to the development of new business models (e.g. commission-free trading apps) and competition among internet-based securities brokers, resulting in reduced investment costs for retail investors.

…but also result in investor harm, e.g.:

• gamification and other such techniques can push investors to take actions based on emotions rather than through rational decisions (based on ESMA’s 2021 call for evidence on certain aspects relating to retail investor protection) and incentivise inappropriate gambling-like and other behaviours (e.g. trading too frequently and “herd investing” (based on a 2022 FCA article on gaming trading)), which may lead to poor outcomes.
• Social media may promote excessive speculation and lead to investment not based on fundamentals. Also, marketing on social media may sometimes be aggressive, provide overly promotional / unbalanced information and sometimes even provide false or misleading information.
• Firms may be operating under existing regulatory structures or exemptions to offer products in ways or to an extent that may not have been envisaged. IOSCO’s examples include fractional share trading (trading of products simulating fractions of shares, but which are actually derivatives/other structures linked to the value of an underlying share which come with additional risks and costs) and copy trading (involving trading of a client’s assets based on the trades of another trader), both of which raise investor protection issues (as recently highlighted by ESMA and Belgium’s FSMA in statements on fractional share trading and ESMA’s supervisory briefing on copy trading).
• Technological developments have been key in enabling the development of crypto-asset activities, but since regulations have not necessarily kept up retail investors may be investing without investor protections such as adequate product disclosures.
• Online scams are a key method used by fraudulent firms to target investors. Also, novel forms of technology-based and crypto-asset fraud are increasing. IOSCO notes that in the overall scheme of fraud patterns, “online scams” cause the “most harm”. For the wrongdoers, they are low risk, high volume and enable them to remain largely disguised. Many such scams involve a cross-border fact pattern in part because of the challenges faced by regulators in supervising and taking enforcement action against such activity. For example:
  • direct targeting via social media (i.e., Instagram, Facebook, dating apps, etc.) is a very common method used to perpetrate cross-border fraud, e.g. firms using social media to purport to be authorized and claim to be based in the investors’ “home” jurisdiction”; and
  • IOSCO notes that a common scenario in the EU is the redirection of investors from an authorized EU service provider to an authorised third-country subsidiary. Digital platforms can make it difficult for the retail client to identify the legal entity that ultimately offers and provides the products.

Supervising online activity presents particular regulatory challenges

IOSCO notes that regulators face particular difficulties identifying “bad actors” and bringing enforcement action. The report explains that this challenge mainly emanates from some of the unique features of the internet and social media which include e.g. nearly instantaneous communication with many users in multiple jurisdictions at a relatively low cost via webpages that appear legitimate, the potential for anonymity and the sheer volume of content.

Also, online misconduct often involves cross-border elements, which present additional challenges. For example, the regulator of the jurisdiction where products are offered is not always the competent authority of the entity behind the offering.

What could regulators be doing to enhance their supervisory capabilities?

IOSCO urges regulators to consider a range of measures to address potential retail investor harm at its source and eliminate detrimental online marketing channels, including:

• using advance technologies e.g. AI/machine-learning “webscraping” and natural language processing techniques and other scanning tools to monitor online content; for example, such tools could be used to identify if sustainability disclosures meet jurisdictional requirements;
• using “real-time technical tools” for real-time listening against malicious activities and publicising trigger incidents;
• enhancing in-house capability or using third party vendors to filter through the data collected;
• issuing real-time warnings / public alerts to retail investors, including on social media (e.g. the US SEC has issued alerts including on social media cautioning investors and the HK SFC has warned the public about online scams on its Facebook page);
• in relation to crypto-assets, requiring market participants to provide information on the volume of retail investor crypto activities (e.g. to help regulators to identify pump and dump schemes);
• increasing efficient cross-border cooperation and collaboration in investigations and enforcement actions, in particular in the area of crypto-assets, including by:
  • working with other types of regulators including criminal authorities and those dealing with banking, consumer and AML requirements (e.g. the HK SFC has collaborated with fellow regulators in Mainland China and overseas markets such as Singapore as well as police forces on the basis of MoUs); and
  • partnering with other types of organisations including online platforms;
• using intrusive supervision and enforcement techniques (e.g. Canada’s OSC uses “knock-and-talks” techniques, which involve, with the assistance of a police officer, knocking on the door of a subject of enquiry to obtain a more rapid outcome than a lengthy investigation/hearing process);
• using mystery shopping to supervise the point of sale; and
• introducing greater investor protections in the marketing of high risk products e.g. obligations to publish clearer risk warnings.

Also, although not included in its list of recommendations, IOSCO notes that some respondents to its March 2022 retail market conduct consultation paper supported mandatory reporting imposed on firms who are working with finfluencers.

For more detail on the issues above and to read IOSCO’s final report in full, see the report here.

* As described by IOSCO members and stakeholders.