European securities regulators have issued guidance on compensation practices, which aims to improve investor protection by preventing the use of distorting incentives.

A new paper published Monday by the European Securities and Markets Authority (ESMA) seeks to improve the implementation of rules on conflicts of interest, thereby preventing mis-selling of financial products. The draft guidelines will apply to investment firms, credit institutions, fund management companies when providing investment services, and regulators.

The key elements of the guidelines include general obligations that firms should design and monitor their remuneration policies and practices to take account of the conduct of business and conflicts of interest risks that may arise; that they should set up adequate controls over their remuneration policies to ensure that they deliver the intended outcomes; and, that firms ensure that remuneration is not paid in a way that aims at circumventing the rules and guidelines.

The paper says that ESMA believes that sound remuneration policies “are fundamental in guaranteeing a high level of protection offered to investors and eliminating perverse incentives that can lead to practices such as mis-selling of financial products which are not appropriate for investors, or investment choices which are sub-optimal.”

The initiative from the ESMA comes in the wake of an initiative from the UK’s Financial Services Authority (FSA) to address poorly designed incentive schemes. Earlier this month, the FSA published draft guidance that aims to help firms comply with existing regulatory principles, which demands that firms craft fair incentive schemes and that they have a strategy for mitigating the risk of improper sales. The draft guidance is open for consultation until Oct. 31; and the FSA is also considering new rules too, along with a wider review of incentives, and possible enforcement action.

“During the last decade we have seen a number of mis-selling scandals affect the retail investor across Europe, ranging from pensions to mortgages to investment products. A key factor identified as a driver for the promotion, recommendation and selling of unsuitable products is the presence of financial incentive schemes for sales staff that do not take account of the clients’ best interests,” said Steven Maijoor, ESMA chair.

“Today’s proposed remuneration guidelines for [investment firms] are key to ensuring that the pay and incentive structures for sales staff and their superiors do not create false incentives when selling financial products to retail investors. The consistent application of ESMA’s remuneration guidelines will help strengthen investor protection and achieving the same level of protection for Europe’s retail investors no matter where they invest,” adds Maijoor.

The deadline for comments is Dec. 7, and the ESMA says it expects to publish a final report, and final guidelines, by the second quarter of 2013.