Miguel Puertas – Asset Growth EAF.
Over the past 15 years, global financial markets have witnessed a significant increase in the regulation of investment service firms. These measures, driven by governmental and supranational bodies, are intended to protect end investors, promote transparency, and ensure financial stability.
However, despite these underlying intentions, the level of investor protection has not always improved. In this article, we analyze the reasons why, in our view, the increase in regulation has not necessarily resulted in greater security for retail investors. In some cases, it may even generate counterproductive effects.
Excessive Complexity in Regulation
One of the main problems associated with increasing regulation is the complexity it creates. Extensive and detailed regulatory frameworks can make understanding difficult for both companies and investors.
Regulations such as MiFID II in the European Union, although well-intentioned, have generated an enormous administrative burden for firms, often making it harder for investors to fully understand the financial products and services they acquire.
When regulations become overly complex or extensive, end investors face an overwhelming amount of technical and legal information. Rather than adding value and improving decision-making, this information overload can create confusion and reduce investors’ ability to make informed decisions.
Very few clients actually read and fully understand the content and scope of the documentation presented to them for signature.
Rising Costs and Limited Access
Regulatory compliance has led to a very significant increase in costs for investment service firms. These companies must invest in advanced technological systems, staff training, legal consulting, and external audits to comply with the regulatory framework.
These additional costs are ultimately transferred to end clients through higher commissions, increased fees, or lower net investment returns, since otherwise many firms would struggle to remain financially viable.
In fact, many firms and professionals have been forced either to merge with larger companies or cease operations entirely.
This consolidation and the rise of entry barriers reduce competition and limit the options available to investors, who increasingly find themselves dealing with a small number of large institutions that dictate terms and pricing.
Focus on Formal Compliance Instead of Real Protection
Many regulations are designed to ensure that firms comply with formal standards, such as information disclosure requirements, investment suitability assessments, convenience tests, or periodic sustainability evaluations.
While these measures are important, they often become bureaucratic exercises that do not necessarily translate into better investor protection. Instead, they generate such a large amount of documentation that investors are discouraged not only from understanding it, but even from reading it at all.
For example, the abundance of disclosure documents and mandatory statements can lead to a “box-ticking” approach rather than meaningful interaction between firms and clients.
In this context, many companies prioritize meeting legal and formal requirements instead of providing genuinely tailored services adapted to the client’s actual needs.
Limited Innovation and Standardized Products
Heavy regulation and increasing restrictions can hinder innovation in the financial sector. Firms, fearful of breaching complex regulations, often avoid launching new products or services that could potentially benefit investors.
Instead, they focus on offering standardized products that comply with regulations but do not necessarily meet the specific needs of different investor profiles or deliver acceptable returns relative to the risks assumed.
This phenomenon is particularly concerning in a world where investors increasingly seek personalized solutions and strategies tailored to their unique financial goals.
Although thousands of new products continue to be registered every year, many are merely repackaged versions of existing offerings.
The costs associated with products or services are not always easily accessible to end investors. Service agreements frequently refer to sections on the company’s website — often difficult to locate — that can be updated unilaterally without notifying the client and that often fail to reflect individually negotiated agreements.
What is the value of including such generic and poorly tailored information for a specific client?
A False Sense of Security
An unintended consequence of increased regulation is that some investors may assume that all products and services offered in regulated markets are completely safe or will behave exactly as described in the signed documentation.
This overconfidence can reduce investors’ due diligence, leading them to delegate full responsibility to firms and regulators, often more out of ignorance of the industry than by deliberate choice.
However, financial risk can never be entirely eliminated. While regulations may mitigate certain risks, they cannot foresee every possible contingency, such as economic crises, failures in business models, or the limitations implied by 95% or 99% confidence intervals regarding investment behavior.
When investors operate under a false sense of security, they may expose themselves to significant losses and emotionally driven decisions that crystallize losses which may never be recovered.
This was particularly evident during the 2008 global financial crisis, the market collapses caused by COVID lockdowns in 2020, and the monetary policy normalization by central banks in 2022.
These are examples of what the financial world refers to as a “black swan,” a term popularized by Nassim Taleb.
For instance, a conservative investor seeking only European or U.S. sovereign debt for maximum stability may struggle to understand why their portfolio lost more than 20% in 2022 — despite having signed all legally required documentation and compliance forms before investing.
Challenges in Implementation and Supervision
The success of any regulatory framework depends on effective implementation and proper supervision. Combined with the interpretative nature of certain rules, this can create inconsistencies in the level of investor protection.
Furthermore, regulatory gaps and the lack of coordination across jurisdictions can create problems in increasingly globalized markets.
End investors, particularly those with internationally diversified portfolios, may remain exposed to risks not contemplated by local regulations, while also facing restrictions on access to certain products.
A practical example in Spain occurs when a client wishes to purchase a U.S.-based ETF that lacks mandatory documentation translated into Spanish. Regardless of the client’s understanding or willingness to invest, retail investors are prohibited from accessing it unless they are classified as professional investors.
Who decided that retail clients do not understand English while professional clients do?
The Need for a Balanced Approach
For regulation to be truly effective, it must strike a balance between protecting investors and allowing markets to function efficiently.
This means simplifying regulatory frameworks, prioritizing financial education, and ensuring that regulations focus on delivering tangible outcomes for consumers.
Additionally, regulators should work more closely with the industry to develop rules that reflect market realities, limit abuses, and create processes capable of identifying irregularities effectively.
Conclusion
Although the intention behind increasing regulation is to protect end investors, in our opinion, this objective is not being fully achieved.
Complexity, bureaucracy, rising costs, reduced innovation, and a misleading perception of safety are just some of the associated challenges.
Moreover, regulation is increasingly restricting access to certain investment products — particularly third-party funds — for smaller investors.
In many cases, investors need to meet minimum wealth thresholds associated with private banking in order to access products managed by firms other than their custodian bank.
To move toward a more effective system, it is essential to rethink the regulatory approach, placing greater emphasis on education, simplicity, and collaboration among all market participants.
Only then can a genuinely sustainable level of investor protection be achieved without suffocating the dynamism and competition that allow financial markets to thrive.