Information, recommendations, and advice as sources of systemic risks

One of the main day-to-day activities of financial and banking companies is to disseminate a wealth of information to their clients to inform them or indicate the strategies to follow in relation to short-term conditions and medium-term market forces.

How this information is disseminated to clients is of major importance, both to the firms and to the recipient clients, i.e., investors and traders.

Above all, however, the way information is disseminated of decisive importance for economies, credit and financial markets. The determining importance is due to the fact that information in the form of a recommendation or advice about a type of product to a critical set of customers is likely to create a trend in the economy and markets and, therefore, systemic market risk. Remember the information that was given in the form of recommendations to a critical mass of clients in cases such as dot.com companies, securitized loans, government bonds, etc., where all these cases led to financial and market crises.

The difference between information and recommendations or advice is subtle

The big issue with disseminating information to the public and clients centres on the fact that the distinction between information and recommendations or advice is blurred. The point is that when financial companies or banks inform their customers about market conditions or the products they provide, they are indirectly or directly dictating this information in a way that suggests a personal recommendation or advice to the customers. In fact, it is common practice when providing information to their clients to suggest courses of action with specific recommendation guidelines, which are personal advice.

According to MiFID, investment advice means the provision of personal recommendations to a client, either at his request or at the initiative of the investment firm, regarding one or more transactions relating to financial instruments. A recommendation requires an element of opinion on the part of the adviser. In effect, the advice includes a recommendation as to a course of action that may be presented as being in the investor's best interest.

If the information given were available without discrimination directly and easily to all customers, it would not constitute a personal recommendation or advice. But in most cases, financial companies provide specific information to a specific type of customer whose profile they know is affected by that information. The goal is to direct these customers to specific strategic options for investing or trading financial products that are usually satisfied by the products provided by these financial companies. Essentially, the companies provide personal recommendations and advice to customers.

The investment profile and distribution channels

While a company may not intend to provide a recommendation to a customer, it can be found to do so if it allows the information it provides to become subjective so as to lead the customer to a particular product over others. Information is not a recommendation if it includes statements of facts or figures and the information is provided objectively without any comment or value judgment regarding an investor's decisions.

However, if a company knows the investment profile of a specific investor and uses it to determine a specific set of products to present as a portfolio suitable for that investor, then the service provided is equivalent to an investment recommendation or advice.

Everyone must be aware of the risks

When banks and financial firms have a deep understanding of the investment profile of their customers, then they have a powerful tool to indicate the investment products that are suitable for their customers. In this case, they make recommendations and advice to their customers. Knowing the client's investment profile is not negative action from a financial company, nor the recommendation and advice to clients.

However, they should know that if investment profiles use them en masse through specific channels, then given that they provide recommendations and advice to a critical mass of clients, they ultimately influence them en masse and, therefore, potentially participate in creating trends in the economy and markets. This means that they can potentially generate systemic risks such as market risk. And this is something that should not be ignored either by traders and investors or by companies. Mainly, however, it cannot be ignored by the institutions that supervise the proper functioning of the advisory service so that the systemic risk that is produced is manageable.

---