In part 1 of this article, we examined three of the six key areas of overlap between the regulations on PRIIPs and MiFID II/R. In particular, we provided detail on, and discussed the degree of similarities between, the scope, the disclosure requirements for financial instruments and the obligations to identify a ‘target market’ between both regulations.
This article continues by outlining the requirements and providing a verdict on the remaining three area of overlap; costs and charges, risk disclosure and product reviews (see the image below).
- Costs and charges
Regulation on PRIIPs
In the section of the KID entitled ‘What are the costs?’, both direct and indirect costs associated with an investment in the PRIIP should be listed, this would include:
- One-off costs: entry and exit costs
- Ongoing costs: portfolio transaction costs, insurance costs and other ongoing costs
- Incidental costs: performance costs and carried interests.
Under MiFID II/R, information about all costs and charges should be aggregated. This is to allow the client to understand the overall cost, as well as the cumulative effect on return of the investment.
Further to this, when a client requests the investment firm to do so, an itemised breakdown must also be provided. For example, the breakdown should include:
- One-off costs: front-loaded management fee, structuring fee and distribution fee
- Ongoing charges: management fees, service costs and financing costs
- All costs related to the transaction: entry and exit costs, transactions tax and foreign exchange costs
- Incidental costs
- Performance costs.
Verdict on overlap for costs and charges
MiFID II states that where there is “sufficient information in relation to the costs and associated charges … in respect of the financial instrument itself is provided in accordance with other Union law that information should be regarded as appropriate for the purposes of providing information to clients under this Directive”.
Under MiFID II, investment firms distributing financial instruments must inform clients about all the other costs and associated charges relating to their provision of investment services in relation to that financial instrument. Therefore, whilst firms could rely on the information provided under the section ‘What are the costs?’ of the KID, there may be additional cost and charge related information that must be disclosed.
- Risk disclosure
Regulation on PRIIPs
Under the KID section ‘What are the risks and what could I get in return?’, PRIIP manufacturers are asked to provide a brief description of the risk-reward profile by detailing the following elements:
- A range of risk classes for all the underlying investment options being offered within the PRIIP. This is done by using a summary risk indicator (SRI), which has a numerical scale from 1 to 7. The SRI figure is supplemented with an explanation of that indicator, its main limitations and detail on any materially relevant risks that may not be adequately captured by the SRI
- A statement indicating that the risk and return of the investment varies based on the underlying investment option
- The maximum possible loss of invested capital; detailing whether the retail investor can lose all invested capital or whether the retail investor bears the risk of incurring additional financial commitments or obligations and, where applicable, whether the PRIIP includes capital protection against market risk and the details of its cover and limitations
- A brief description on how the performance of the PRIIP depends on the underlying investment options.
Under article 24(4) of MIFID II, firms are obliged to provide information on financial instruments and their proposed investment strategies. This must include appropriate guidance on, and warnings of, the risks associated with investments in those instruments or in respect of particular investment strategies.
The guidance shall include:
- The risks associated with that type of financial instrument, including an explanation of leverage and its effects and the risk of losing the entire investment
- The volatility of the price of such instruments and any limitations on the market for such instruments
- Information on impediments or restrictions for disinvestment
- The fact that an investor might face financial commitments and other obligations in addition to the cost of acquiring the instruments
- Any margin requirements or similar obligations, applicable to those types of instruments.
Verdict on overlap for risk disclosure
Whilst the regulation on PRIIPs specifies that a SRI must be included on all KIDs, under MiFID II firms are required to develop their own methodology when it comes to risk rating products. As retails clients fall under the scope of both MiFID II and the regulation on PRIIPs, firms will have to decide whether to apply the same or different approaches when it comes to disclosing risks to all clients.
The information within the KID must be reviewed regularly by the PRIIP manufacturer and should also be revised promptly when a review indicates that changes need to be made.
Investment firms that manufacture financial instruments for sale to clients are required to maintain, operate and review a process for the approval of each financial instrument before it is marketed or distributed to clients.
These investment firms are also obliged to regularly review the financial instruments they offer or market, considering any “event that could materially affect the potential risk to the identified target market, to assess at least whether the financial instrument remains consistent with the needs of the identified target market and whether the intended distribution strategy remains appropriate”.
A review of the KID is a PRIIPs obligation and there is a similar obligation to review products under MiFID II, albeit with a wider scope for review. It has been suggested that KIDs will have to be published, made available and reviewed both on an annual and on an ad hoc basis if the product continues to be sold.
Overall verdict on the overlap between the regulation on PRIIPs and MiFID II
Although the MiFID II requirements are somewhat broader than those under PRIIPs, there is some alignment in the obligations on product disclosure. With several regulatory disclosure requirements already in place, and considering that both the regulations on PRIIPs and MiFID II will impact how firms develop, market and sell products to their customers, firms should be looking at both in conjunction.
Whilst the alignment of regulatory programmes is essential for firms that are impacted by multiple regulations, differences in the timing of implementation and development of additional rules can be challenging to manage. This can be seen in those firms wishing to align their implementation efforts for MiFID II and the regulation on PRIIPs as there is still a great deal of uncertainty and surrounding both regulations. Furthermore, whilst the PRIIPs regulation becomes applicable this year (31 December 2016), the application date for MiFID II has been pushed back by a year (3 January 2018) and, therefore, there is a risk that additional details for the MiFID II obligations could be provided, which do not align with the current implementation thinking on PRIIPs.
Saying this, without the PRIIPs KID satisfying the MiFID II requirements, the KID will just become another document provided to retail investors alongside disclosures provided under MiFID II, which would increase the documentation that retail investors receive when buying financial products.
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