Today, the European Commission (Commission) published its Retail Investment legislative package with the aim of empowering retail investors to take more informed investment decisions that would better correspond to their investment needs and objectives. During the run-up to the Commission’s proposal, a number of issues were intensively debated by policymakers and stakeholders. The most controversial issue, a full ban on inducements, is not part of the final Commission proposal. Nevertheless, the issue will come up during the legislative process and the debate is likely to continue.
Here are the ten key things to know about the Retail Investment Strategy:
The strategy includes proposed reforms to a large number of EU rules
The Retail Investment Strategy consists of a legislative package that will amend a large number of legal texts in the fields of market conduct, asset management and insurance. In particular, the legislative proposals will amend the:
- Markets in Financial Instruments Directive II (MiFID II).
- Alternative Investment Fund Managers Directive (AIFMD).
- Undertakings for Collective Investment in Transferable Securities Directive (UCITS Directive).
- Directive on the provision of insurance or reinsurance distribution services to third parties (IDD).
- Directive on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II).
- Regulation on key information documents for packaged retail and insurance-based investment products (PRIIPs).
Amended thresholds for client categorisation
The Commission proposes to amend the identification criteria for clients that may be treated as professional clients on request by lowering the wealth criterion from EUR 500,000 to EUR 250,000 and insert a fourth criterion relating to relevant education or training. Legal entities will also be able to qualify as a professional client on request by fulfilling certain balance sheet, net turnover and own funds criteria.
Introduction of risk warnings
The proposal amends Article 24 of MiFID II to require investment firms to display appropriate risk warnings in all information materials concerning particularly risky products, in order to alert retail investors to specific risks of potential financial losses. The European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA) will be able to issue guidelines that specify the concept of particularly risky financial products, and develop regulatory technical standards (RTS). In addition, the two European supervisory authorities will have the competence to impose the use of risk warnings on investment firms, insurance undertakings and insurance intermediaries, after consulting the relevant Member State national competent authority (NCA).
New requirements on marketing communications:
The Commission proposal introduces a number of requirements regarding marketing communications. Under an amended Article 9(3) MiFID II, investment firms will be required to have a policy on marketing communications and practices, which needs to be defined, approved, and overseen by the management body. Effective organisational and administrative arrangements should be put in place to ensure compliance. A new Article 24c MiFID II includes obligations to clearly identify marketing communications to ensure that they are appropriately attributed to the investment firm on whose behalf they are made. Essential characteristics of the investment product or service should also be clearly presented in all marketing communications. The provision also includes a division of responsibility with respect to the content and use of marketing communications between manufacturers and distributors of investment products.
Amendments to product governance rules
A new Article 16a MiFID II and amendments to Article 25 IDD would strengthen product governance rules and regulate pricing processes. The amendments, which would apply to PRIIPs and insurance-based investment products, both at the product manufacturer and distributor level, would limit the offer of products that bear poor or no “Value for Money” for retail investors. The current product governance frameworks are complemented by new requirements on manufacturers to set out a pricing process allowing for the identification and quantification of all costs and charges, and the assessment of whether such costs and charges do not undermine the value which is expected to be brought by the product. Regarding PRIIPs, the pricing process will be strengthened by, among other things, a requirement not to approve products that deviate from the relevant benchmark, unless the manufacturer can show that the costs and charges are justified and proportionate. Similar requirements are introduced in the UCITS Directive and AIFMD.
The introduction of new costs and charges disclosures
The Commission proposal introduces a new Article 24b MiFID II on costs and charges disclosures. This new Article moves the existing provisions on cost and charges disclosures under Article 24(4) of MIFID II to the new Article and standardises the presentation of cost and charges information. With regards to third party payments, the new provision also requires investment firms to explain the purpose of such payments and quantify their impact on expected returns, in a standardised and comprehensible manner. All investment firms will be required to provide their retail clients with an annual statement on costs and charges. In addition, the proposal amends Article 29 IDD to complement the existing provisions on pre-contractual disclosures in the distribution of insurance-based investment products by adding a requirement to disclose information on all costs and associated charges, and their impact on expected returns. ESMA and EIOPA will be empowered to develop draft RTS that will set out the format and terminology that should be used by firms for the disclosure of the costs and charges information.
Limited ban on inducements
A new Article 24a MiFID II introduces a ban on inducements paid by manufacturers to distributors in relation to the reception and transmission of orders, or execution of orders to or on behalf of retail clients. This proposed ban includes inducements for execution-only sales. However, the ban is not applicable to situations where investment firms provide advice relating to the same transaction or in relation to fees or remuneration received or paid from an issuer for placement and underwriting services. Minor non-monetary benefits not exceeding EUR 100 or of a scale and nature such that they could not be judged to impair compliance with the duty to act in the best interests of the retail investor would also be allowed, under the condition that they are clearly disclosed.
Measures on improving quality of advice
Earlier in the process, the Commission was considering the introduction of a quality label for investment advisors. Following a public consultation, the Commission decided not to pursue this further. Instead, the Commission has introduced rules aimed at strengthening and aligning the requirements concerning the knowledge and competence of investment advisors by amending Article 25 MiFID II and Article 10 IDD. In MIFID II, a minimum requirement for ongoing professional training is also introduced, which already exists in IDD.
In addition, the Commission will introduce a new test replacing the “quality enhancement” test to ensure that investment firms act in accordance with the best interests of their clients and customers. Under the new test, financial advisors must: (i) base their advice on an assessment of an appropriate range of financial products; (ii) recommend the most cost-efficient financial product from that range; and (iii) offer at least one financial product without additional features which are not necessary to the achievement of the client’s investment objectives.
Amendments to the suitability assessment framework
The Commission proposal amends Articles 25 MiFID II and Article 30 IDD to require investment firms, as well as insurance undertakings and insurance intermediaries distributing insurance-based investment products, to explain the purpose of their assessment of appropriate financial products to their retail investors in a clear and simple manner. They must also obtain all relevant information from such investors which may be necessary and proportionate for these assessments. Retail investors will need to be informed, via standardised warnings, about the consequences on the quality of the assessment where they do not provide accurate and complete information. In addition, the proposal will introduce the possibility for independent advisors to provide advice although this will be limited to a sufficient range of diversified, non-complex and cost-efficient financial instruments.
The legislative process will take at least one year
Following today’s publication, the legislative package will be submitted to the European Parliament and the Council, who will articulate their respective positions on the proposed reforms. It is expected that the European Parliament and the Council will need at least one year before they can reach a common position on the Commission’s proposals. The legislative process may be delayed significantly as a result of the European Parliament elections, which will take place in June 2024.