Background
“Only 38% of consumers are confident that the investment advice they receive from financial intermediaries is primarily in their best interest”, a recent Eurobarometer survey revealed.1
The current trend is towards more retail investments, notably driven by retail-oriented initiatives such as the newly introduced ELTIF reform – please refer to our dedicated page on this topic – . In this context, the European Commission (the EC) is constantly seeking to create an improved and fairer market, increasing trust, and encouraging retail investors’ participation in capital markets.
On 24 May 2023, the EC put forward its long-awaited Retail Investment Strategy (RIS). It aims at strengthening the current legislative framework to ensure retail investors are adequately protected and can take informed investment decisions suited to their needs.
The RIS is composed of (i) an omnibus directive (the Omnibus Directive) amending the directive on markets in financial instruments (MiFID II), the directive on insurance distribution (IDD), the directive on the taking-up and pursuit of the business of insurance and reinsurance, (Solvency II Directive), the directive on undertakings for collective investment in transferable securities (UCITS Directive) and the directive on alternative investment fund managers (AIFMD), and (ii) a regulation (the Regulation) amending the Regulation on key information documents for packaged retail and insurance-based investment products (PRIIPS Regulation).
This publication will intentionally only focus on key RIS amendments to MiFID II, the AIFMD, the UCITS Directive and the PRIIPS Regulation.
Most significant amendments to mifid ii, the aifmd and the ucits directive
Information disclosure and risky products
Under Article 24 of MiFID II, investment firms would be required to display appropriate warnings in information materials (e.g., marketing communication) provided to potential or existing retail clients about specific risks of potential losses carried by particularly risky financial instruments. ESMA shall develop (i) guidelines on the concept of particularly risky financial instruments and (ii) regulatory technical standards determining the content and format of such risk warnings.
Further standardisation of the information disclosure on costs, associated charges and third-party payments is provided for, while ESMA would develop regulatory technical standards setting out the format and terminology to be used for such purpose. Investment firms are subject to an enhanced information requirement on costs and charges when providing certain services. Investment firms will indeed be required to communicate to all retail clients an annual statement including, inter alia, information on costs and charges and performance with varying minimum information requirements to be included in such annual statement depending on the type of investment products offered.
Qualification as “professional”
The Omnibus Directive suggests (i) easing restrictions for investors to qualify as “professional” under MiFID II by reducing the wealth criterion from EUR 500,000 to EUR 250,000 for those who wish to be treated as professional (professional on demand), and (ii) adding a fourth possible criterion relating to relevant education and training.
Undue costs
Article 12 of the AIFMD would be amended to include additional requirements for AIFMs (i) to act in such a way as to prevent undue costs from being charged to AIFs and their investors, (ii) to maintain, operate and review an effective pricing process allowing for the identification and quantification of all costs borne by AIFs and their investors, and ensure that the costs are justified, proportionate and not undue, (iii) to assess at least annually whether undue costs have been charged to AIFs or their investors, and if so, reimburse such undue costs and report them to the AIF’s and AIFM’s home competent authorities, (iv) to assess at least annually whether costs borne by retail investors are justified and proportionate and make a comparison with the relevant benchmark on costs and performance which ESMA shall develop.
Costs would be considered as “due” when they:
- are in line with disclosures in the prospectus, the fund rules or instruments of incorporation and the key investor information under the PRIIPs Regulation;
- are necessary for the AIF to operate in line with its investment objective or to fulfil regulatory requirements; and
- are borne by investors in a way that ensures fair treatment of investors, except where the AIF’s rules or instruments of incorporation provide for preferential treatment.
The Commission shall adopt, by means of delegated acts, measures to notably specify the minimum requirements for the pricing process to prevent undue costs from being charged to AIFs and their investors, provide for criteria to determine whether costs are justified and proportionate, and determine the methodology used by ESMA to develop its benchmarks.
Please note that similar changes would be carried out in the UCITS Directive.
Ban on inducements
Inducements requirements are significantly amended. In addition to the ban on receiving inducements when providing the service of portfolio management, investment firms carrying such activity are also prohibited from paying inducements. Furthermore, the Omnibus Directive introduces a new ban on inducements from manufacturers to distributors with regards to the reception and transmission or execution of orders to or on behalf of retail clients would be introduced under MiFID II. This prohibition does not apply where an independent advice relationship exists between the retail client and the investment firm. Further exceptions are also provided for.
“Best interest” test
Further amendments would be made to strengthen the obligation for investment firms, when providing investment advice, to act in the best interest of their clients with the introduction of a “best interest” test, requiring investment firms to (i) base their advice on an assessment of an appropriate range of financial products, (ii) recommend the most cost-efficient financial product from the range of suitable financial products, and (iii) offer at least one financial product without additional features which are not necessary to the achievement of the client’s investment objectives and that give rise to additional costs.
Suitability and appropriateness tests
The amendments include enhancements to the suitability and appropriateness tests by notably introducing (i) the obligation for investment firms to explain the purpose of the assessments to clients and a clear and simple way and to obtain all relevant information from them which may be necessary and proportionate for such assessments, (ii) the requirement to inform retails investors via standardised warnings about the consequences on the quality of the assessment if they do not provide accurate and complete information, (iii) the possibility for retail investors to receive, upon request, a suitability assessment report and seek additional clarifications, where needed, (iv) the addition of portfolio diversification as one of the elements that investment firms need to assess when considering the suitability of a specific product, (v) the possibility for independent advisors to provide advice limited to a range of diversified, non-complex, and cost-efficient financial instruments, with less burdensome tests, and (vi) the expansion of the scope of the client’s information that intermediaries need to assess to include the capacity to bear full or partial losses and risk tolerance.
Reporting of cross-border activities
The proposal introduces a new requirement for investment firms and credit institutions providing investment services or activities to report specific information annually to the competent authority of its home Member State when they provide investment services to more than 50 clients on a cross-border basis, including inter alia the list of countries and the type, scope and scale of services provided.
ESMA shall develop draft technical standards on the details of the exact information to be included, as well as the format, methods, transfer arrangements, frequency, and starting date for the information to be reported.
Marketing communications
The Omnibus Directive also introduces a set of new rules to protect retail investors from misleading marketing communications, including inter alia (i) a requirement for investment firms to have a policy on marketing communications and practices, (ii) a requirement for investment firms to have effective organisational and administrative arrangements in place to ensure compliance with all obligations related to marketing communications and practices; (iii) the obligation to clearly identify marketing communications and divide the responsibility with respect to the content and use of such marketing communications between manufacturers and distributors, and (iv) a requirement for Member States to ensure firms’ management bodies receive annual reports on the use of marketing communications, compliance with the above obligations, potential irregularities and suggested solutions. Finally, the record-keeping obligation of 5 years would be extended to all marketing communications and national competent authorities would be empowered to act in case of non-compliance with the above-mentioned obligations.
Financial education
The Omnibus Directive suggests adding a new title on financial education under MiFID II, encouraging Member States to promote measures that support the education of retail clients and prospective retail clients in relation to responsible investment when accessing investment services or ancillary services
Most significant amendments to the priips regulation
The Regulation aims at making the PRIIPS KID more consumer friendly, while complementing other measures of the Omnibus Directive to strengthen the level of investor protection and includes, inter alia:
- the introduction of new section in the PRIIPS KID titled “Product at a glance” summarising the most essential characteristics of an investment product;
- new rules for presenting costs of multi-option products (MOPs) to ease investor’s choice between available investment options;
- the exclusion of retail products providing immediate annuities without redemption phase from the scope of the PRIIPS Regulation;
- the exclusion of corporate bonds with make-whole causes from the scope of the PRIIPS Regulation, provided that they are redeemed at fair value;
- the withdrawal of the “comprehension alert” due to its limited efficiency;
- the introduction of a dedicated sustainability section in the PRIIPS KID titled “How environmentally sustainable is my product?” providing key information on the sustainability profile of the relevant investment product, for which the ESAs will specify the content in dedicated regulatory technical standards; and
- the preference for KIDs to be provided in an electronic format, building on established practices from the MiFID framework.
What’s next
At this stage, the RIS is only at the proposal stage of the EU decision-making process and still needs to be reviewed by the European Parliament and the Council of the European Union before its formal adoption. Both the Omnibus Directive and the Regulation shall enter into force on the 20th day as from publication in the Official Journal of the European Union and shall apply 18 months after their entry into force.
1 Eurobarometer survey monitoring the level of financial literacy in the EU, 2023.
