On 17 June 2016, the Council of the European Union approved a one-year delay to the MiFID II transposition and implementation dates. Under the new regulation, the deadline for Member States to transpose MiFID II into national legislation is 3 July 2017 and the date of application for MiFID II/R is now set for 3 January 2018.
In recent months, there has been a great deal of lobbying by the industry to delay the current implementation date of the Regulation on Packaged Retail and Insurance-based Investment Products (PRIIPs). The aim of the Regulation “is to encourage efficient EU markets by helping investors to better understand and compare the key features, risk, rewards and costs of different PRIIPs, through access to a short and consumer-friendly Key Information Document (KID)”. The formal request for postponement by representative bodies of EU banking, insurance and asset management industries in late April 2016 was rejected on 18 May 2016 by the European Commission.
This refusal to delay the implementation deadline means that firms providing investments or investment services to retail markets within the EU will have to quickly get to grips with the RTS which have recently been adopted by the European Commission and continue with their implementation programmes if they are to meet the 31 December 2016 deadline.
Considering the upcoming application deadline of the PRIIPs regulation and the overlap of this with MiFID II/R, many firms are looking to see whether they can align their regulatory change programmes. In part one of this article, we outline three of the six overlapping areas in both regulations and provide an overall verdict on the level of commonality.
The image lays out the six areas for discussion.
Regulation on PRIIPs
In one of our previous articles, 10 key questions on the PRIIPs regulation, we defined the term ‘PRIIP’ and provided some examples of products that are caught under the scope of the regulation.
In general, the regulation states that a “PRIIP is an investment where … the amount repayable to the retail investor is subject to fluctuations because of exposure to reference values or to the performance of one or more assets which are not directly purchased by the retail investor, or which is an insurance product that offers a maturity or surrender value that is wholly or partially exposed, directly or indirectly, to market fluctuations”.
Without clear parameters for the concept ‘exposure to reference values’, the interpretation will be wide and, as a result, determining whether a specific product falls within scope of the regulation on PRIIPs may not be straightforward.
Overall, although the FCA’s recent Consultation Paper does not provide a definitive or complete list of products that fall under the definition of ‘PRIIP’, it does provide an indication of the types of retail products that firms should consider to be affected by the Regulation. Even so, as providers continue to innovate and develop new products, it is expected that new product types will emerge and these may also fall within the scope of the regulation.
MiFID II applies to ‘financial instruments’ and the definition of the term has been expanded. Section C from Annex 1 of MiFID II provides a list of 10 categories of financial instruments which fall under the scope of the new regulation coming into force in 2018.
More specifically, the scope of the revised directive has been extended to include:
- Emission allowances
- Physically settled derivatives related to emission
- Commodity derivatives that can be physically settled and that are traded on an OTF.
Wholesale energy products (as defined by REMIT), including natural gas and electricity contracts, that are traded on an OTF and must be physically settled, are exempt.
Verdict on overlap for scope
The Regulation on PRIIPs only applies if a PRIIP is made available to retail investors. A retail investor corresponds to a retail client under MiFID II/R or a customer under the Insurance Mediation Directive, which would not qualify as a professional client under MiFID.
Although there is still some uncertainty on the scope of the regulation on PRIIPs, in general, it can be inferred that all PRIIPs products are also considered to be financial instruments as defined in MiFID II.
- Disclosure on financial instruments
Regulation on PRIIPs
Under the regulation on PRIIPs, anyone advising a retail investor on a PRIIP, or anyone selling one to a retail investor, will have to provide a KID. One of the sections of the KID asks for specific information to be provided under the title ‘What is this product?’. In particular, article 8(3) of the regulation states that the following must be detailed:
- The type of the PRIIP
- Its objectives and the means for achieving them
- Where the PRIIP offers insurance benefits, details of those insurance benefits, including the circumstances that would trigger them
- The term of the PRIIP, if known.
Further to this, a comprehension alert, which should read: “You are about to purchase a product that is not simple and may be difficult to understand”, must be written on a KID when applicable.
In a similar vein, MiFID II requires investment firms to:
- Provide clients or potential clients with a general description of the nature and risks of financial instruments
- Inform retail clients about published prospectuses holding information on a financial instrument that is the subject of a current offer
- Provide information on products that are composed of two or more different financial instruments or services
- Provide information on products that incorporate and guarantee or capital protection.
In addition, as more investors become active within financial markets and are offered more complex sets of services and instruments, the new regulation requires a distinction between complex and non-complex products to be provided to clients. More specially, the directive asks that staff who advise on – or sell – investment products to retail clients possess “an appropriate level of knowledge and competence in relation to the products offered”.
Verdict on overlap for disclosure requirements on financial instruments
Generic information on products is required by both regulations and, although the wording is different, the disclosure requirements on products across the two regulations are broadly aligned. Firms will now be assessing whether, for retail products, a KID can be designed in such a way that it also satisfies the MiFID II disclosure requirements.
- Target market
Regulation on PRIIPs
Under the same section of the KID; ‘What is this product?’, a description of the type of retail investor to whom the PRIIP is intended to be marketed should also be provided.
In particular, this should be in terms of the retail investor’s ability to bear investment loss and take their investment horizon preferences in account.
Under MiFID II/R’s product approval process, a target market for end clients must be identified for each financial instrument. Investment firms should also ensure that all risks relevant to the identified target market are assessed and, further to this, the intended distribution strategy must also be consistent with the target market identified.
Investment firms that manufacture financial instruments will be required to make available all appropriate information on the financial instrument and the product approval process, including the identified target market, to any distributor.
For simple and more common products the target market can be identified with less detail, but, for more complicated or less common products, the target market will have to be identified in more detail.
Verdict on overlap for target markets
Although the regulation on PRIIPs is only aimed at retail clients, for clarity, and to simplify internal processes, it has been suggested that the target market requirements from MiFID II and the intended market requirements under PRIIPs should be aligned.
The industry would require examples within this space as, without them, determining whether manufacturers and distributors are meeting certain obligations may prove difficult. In addition, the use of common language, i.e., the same definitions of the criteria by which ‘target markets’ are defined, may also prove to be key in ensuring alignment across the industry. Ultimately, we need more information on these requirements before being able to say whether they are aligned.
Stay tuned for part 2 of this article, where we will explore the remaining three areas of overlap, costs and charges, risk disclosure and review, between the regulation on PRIIPs and MiFID II.
As always, you can keep up to date with all of the latest MiFID II developments, join our MiFID II LinkedIn discussion group here.