The Commission has published its package of proposals to raise standards in selling consumer investment and insurance products. The package consists of three legislative proposals, comprising one new Regulation and two amending Directives.
The first element of the proposal, and the main driver of change, is a draft Regulation on Packaged Retail Investment Products (PRIPs). The PRIPS Regulation will require production of a clear, consumer-friendly Key Information Document (KID) for each product designated a PRIP. The Commission has chosen not to define a PRIP rigidly, but rather has indicated that it intends to cover all products that:
- are structured, or wrapped, to offer exposures to multiple underlying assets, whatever form they take;
- are designed to deliver capital accumulation over a medium- to long-term investment period;
- offer capital guarantees, with or without a guaranteed proportion of return;
- are insurance products whose surrender values are determined indirectly by returns on the insurance company’s own investments or the profitability of the insurance company and derivative instruments; and
- are normally marketed directly to retail investors.
Its proposed definition refers merely to an “investment product”, which is:
“an investment where regardless of the legal form of the investment the amount repayable to the investor is exposed to fluctuations in reference values or in the performance of one or more assets which are not directly purchased by the investor”.
So what will be a PRIP?
The Commission says the definition will include:
- all types of investment fund (however structured and whether open- or closed-ended);
- insurance-based investments;
- retail structured products; and
- certain private pensions products.
So UCITS will be PRIPs (although, as explained below, not subject to all the PRIPs requirements).
What will not be a PRIP?
Some products will not be PRIPs under the Commission’s definition;
- products where the precise rate of return is set in advance for the entire life of the product, as these carry no investment risk;
- plain shares and bonds, where only a direct holding of the relevant assets is possible;
- deposits which are determined only by an interest rate;
- insurance products that only offer insurance benefits (which will include many general insurance and pure protection policies);
- occupational pension schemes covered by existing EU Directives; and
- pension products which employers are required to contribute to by law and where the employee has no choice over the provider.
And if it is a PRIP?
KIDs must be produced for all PRIPs unless they are UCITS. UCITS must already produce a similar document – the Key Investor Information Document (KIID) – and will be able to continue to produce a KIID for five years after the PRIPs Regulation takes effect. The draft Regulation makes it clear though that any provider also subject to the Prospectus Directive or Solvency 2 in respect of the product must also comply with the requirement to produce a KID.
It is the responsibility of the provider (or any person who changes the risks of a product) to draft the KID which must clearly explain the product’s main features, costs and risks and state whether the investor could lose money by buying the product. The KID must make sense as a stand-alone document. The person making the sale (whether the provider or an intermediary) must provide the KID to any retail investors (as defined in the Markets in Financial Instruments Directive (MiFID)) or customers under the Insurance Mediation Directive (IMD). It is not necessary to provide professional investors with a KID.
When do investors get a KID?
Retail investors must receive the KID in good time before they buy the PRIP. It must be available free and in hard copy if the investor requires it. There are rules for its provision in other formats or via a website, where appropriate.
What will the KID look like?
The draft Regulation is prescriptive. The KID must state clearly that it is a Key Information Document and must bear, directly under the title, the wording:
“This document provides you with key information about this investment product. It is not marketing material. The information is required by law to help you understand the nature of this investment product and the risks of investing in it. You are advised to read it so that you can take an informed decision about whether to invest."
The KID must contain set information under set headings. The KID must include sections on:
- the name of the product and of its manufacturer;
- “What is this investment?” which will give details of the product, some of which will depend on the type of product;
- “Could I lose money?” which will set out the circumstances in which customer loss might occur;
- “What is it for?” which will explain the expected maturity period for the product and liquidity considerations;
- “What are the risks and what might I get back?” which will include the risk and reward profile and risk warnings for the product;
- “What are the costs?” setting out direct and indirect costs;
- “How has it done in the past?” setting out past performance where relevant; and
- “What might I get when I retire” if the product is a pension product.
KIDs must be in clear type and colour, and must be in plain language, not using jargon. Each KID must be in the language of the Member State where the product is sold. There are also rules about use of logos and branding. The Commission and the European Supervisory Authorities (ESAs) will make more detailed rules about content, presentation and revision and review of KIDs.
KIDs should not contain any information other than the required information, and no other marketing information should contradict anything in the KID.
And if the KID is wrong?
If a KID does not comply with the PRIPs Regulation requirements and an investor suffers loss, the investor can claim damages from the product provider. Product providers must ensure they have appropriate complaints handling procedures in place, and Member States must put in place appropriate sanctions for breach of key provisions of the PRIPs Regulation.
The second element of the package consists of revisions to the Insurance Mediation Directive (IMD2). The IMD covers both general and investment insurance products. The Commission is proposing changes that will make regulation of sales of these products more consistent and transparent.
Scope and registration
The IMD will be extended to loss adjustment and claims handling activities, and the Commission has made some changes to the scope of the ancillary business exemption for secondary intermediaries. Mere provision of information will not be an insurance mediation activity.
It will apply to all sales of insurance, whether direct or intermediated, and will require clear status disclosure by the seller. It will also apply to secondary intermediaries, in a proportionate manner (which can include a registration or declaration procedure for certain secondary intermediaries, which sell ancillary, non-investment insurance, or arrangements whereby the intermediary operates under the protection of an insurer or primary intermediary).
Member States must put in place systems for easy online registration and the European Insurance and Occupational Pensions Authority (EIOPA) must put in place a register showing all insurers and intermediaries that have notified their intention to use the IMD passport. The proposal updates the rules and conditions for passporting under the IMD.
Operational and conduct of business requirements
There will be stricter controls over conflicts, which include clear disclosure of the basis and structure on which the seller will be paid, and what costs and charges are included in the premium. Where commission depends on the amount of business written, the details of the arrangements must also be disclosed.
The proposals mirror MiFID in introducing a general obligation to act honestly, fairly and in the best interests of customers and to ensure marketing communications are identifiable as such and are clear and not misleading.
Standards for non-advised sales are broadly unchanged, but there is a new obligation to provide sufficient information about the product for the customer to consider before sale.
The Commission proposes to allow bundling of products, but not tying. Where products are bundled, the seller will have to tell the consumer that the products are available separately.
Tougher requirements for investment insurance
Where the insurance product is investment insurance, there will be tougher rules. The proposals introduce a mandatory “full disclosure” regime for investment insurance, with an “on-demand” regime triggered by a customer request for other insurance (at least for five years, after which it may also become mandatory).
For investment insurance products, there will be provisions on selling standards based on the MiFID 2 requirements for sales, conflict management and disclosures. These will include a requirement to give “honest, professional advice”, and commission will be banned where there is independent advice. These changes also cover suitability and appropriateness requirements. There will also be Level 2 measures applying to investment insurance products, to bring selling standards for these products in line with MiFID requirements.
And if insurers or intermediaries get it wrong?
While IMD2 will still be a minimum harmonisation Directive, meaning that Member States can impose higher standards if they wish, the minimum standards will be a lot higher than those in IMD2. As with the PRIPs proposal, Member States must put in place appropriate sanctions for breach, but the proposals do not cover criminal sanctions.
The final piece of the package sets out amendments to the UCITS Directives (UCITS V). As mentioned above, UCITS will be PRIPs but must already produce the KIID under UCITS IV. This is not identical to the KID because it contains some information specific to UCITS. For five years, UCITS will be exempt from the PRIPS requirements, although the Commission warns it may revisit the KIID in due course. The Commission has focused on making improvements in areas where it says the Madoff affair revealed regulatory gaps.
UCITS V seeks to make clear what the functions and duties of a UCITS depository are. The proposals broadly follow those that will apply to alternative investment fund depositories under the Alternative Investment Fund Managers Directive (AIFMD). The new text explains which entities can act as depositories (credit institutions and investment firms) and the conditions under which depositories can delegate. It has adapted the AIFMD rules so retail investors get the best protection. This includes a ban on the depository discharging its liability through a contractual arrangement where it delegates the custody of assets to a sub-custodian in a third country, even when such delegation is mandatory under the rules of that third country. It also clarifies the depository’s liabilities to replace assets in the event of custodied assets being lost.
The second limb of the proposal addresses potential conflicts and other issues relating to manager remuneration. Remuneration policies should apply to the staff of management companies who can take decisions that have a material impact on the risk profile of a fund and the management company.
Sanctions for breach
The Commission feels there are currently significant inconsistencies in how Member States deal with breaches of UCITS requirements. Its proposals work towards consistent sanctions.
When will the changes happen?
Many of the proposals are consistent with what is already UK practice. Specifically:
- insurers already fall within the insurance mediation regime;
- investment insurance is already treated in a broadly similar way to MiFID investments (falling under the FSA’s Conduct of Business Sourcebook (COBS) rather than the less onerous Insurance: Conduct of Business Sourcebook (ICOBS)); and
- prescriptive information documents and retail investor disclosure standards already exist partly because of the UK’s gold-plating of MiFID.
Others, particularly the UCITS proposals, are not surprising, but will mean more fundamental amendment to UK regulatory requirements.
The proposals will now be discussed within the European Council and Parliament, and the usual reporting, trilogue and voting stages will take place. The Commission hopes to have the new measures in place by the end of 2014.