On 15 April 2014, the EU Parliament and Council agreed the final text of a new proposal to introduce a mandatory disclosure document to be given to retail investors before investing in retail investments. The EU proposal is a regulation on key information documents for packaged retail and insurance-based investment products (the KID Regulation). The KID Regulation was a long time in the making – first proposed in 2009 and spanning several EU presidencies - but agreement was reached simultaneously with agreement on the MiFID 2 package (which the KID Regulation sits alongside). The use of a directly applicable EU regulation is to ensure the intention behind the KID Regulation is met, namely to create a level playing field given the cross-border distribution of investment products.
The KID Regulation is the latest development in the EU’s programme since 2007 of increasing consumer protection as more markets (including those traditionally designed for the wholesale market) open up for retail sector investment and rebuilding confidence in those markets more generally. As well as ensuring better quality and neutrality of advice (which is being addressed by the new MiFID 2 package for investment products and the changes to the Insurance Mediation Directive for insurance-based investment products), the KID Regulation addresses transparency in relation to retail product disclosure.
The KID Regulation closely follows what the EU saw as a big achievement, namely the introduction of a standardised disclosure document for investors investing in UCITS funds. The UCITS measures introduced a key information investor document, or UCITS KIID, for retail investors investing in UCITS. The UCITS KIID replaced the lengthy simplified prospectus that retail investors had to read and understand in order to make an informed investment decision. The UCITS KIID is now being used as the basis for a standardised disclosure document for the majority of investment products available to the retail sector. The intention behind the KID Regulation is to allow investors across the EU to easily compare the key features of investment products to assist their investment decision.
Does the KID Regulation apply to me?
The KID Regulation applies to all manufacturers (or remanufacturers) and financial intermediaries (including advisors) who distribute ‘packaged retail and insurance-based investment products’ (or PRIIPs) which are invested in by retail clients.
What are PRIIPs?
This is a wide definition - which is intentional. Michael Barnier, Commissioner for the Internal Market and Services noted that the KID Regulation “aims to ensure that no investment product slips through the net”. It essentially includes any investment product that is in a packaged form. In order to be in a ‘packaged’ form, a product must either be wrapped or bundled or have other mechanisms that alter an investment in the product compared to a direct holding in the underlying assets. Note here that the definition does not require that the investment products be designed specifically for retail investors. It also includes such products issued by SPVs.
PRIIPs includes investment funds (whether closed-ended or open-ended including UCITS); all structured products, whatever their form (e.g. packaged as insurance policies, funds, securities or banking products); insurance products whose surrender values are determined indirectly by returns on the insurance company’s own investments or even the profitability of the insurance company itself (e.g. with-profits); as well as derivative investments. Structured deposits (as defined in MiFID 2) also fall within the definition.
The KID Regulation also captures those investment products that may not have a packaged element but describe themselves as ‘guaranteed’ where the investment return may vary, or even where all or a portion of the investment return is guaranteed.
Products that are not PRIIPs include the following:
- products where the precise rate of return is set in advance for the entire life of the product;
- basic banking products that contain no element of packaging such as deposit accounts (which are not structured);
- plain shares and bonds (where there is a direct holding of the relevant assets);
- insurance products that only offer insurance benefits, such as pure protection or non-life insurance (where the surrender value is not dependent on fluctuations in the performance of one or more underlying assets or reference values);
- various pension schemes, such as occupational pension schemes and certain other employment based pension schemes which are mandatorily required by national law (e.g. auto enrolled schemes).
What do I need to do if the KID Regulation applies to me?
Similar to the UCITS KIID, the KID Regulation requires a disclosure document, a Key Investor Document (orKID), to be provided to retail investors before investing in PRIIPs. There are particular requirements about the form of the disclosure, who is responsible for disclosure, the medium used to make the disclosure and the timing of disclosure.
Form of disclosure - KID
The form of the KID is prescribed in the KID Regulation. It must be a short document (no more than 3 sides of A4), written in a concise manner, using non-technical language that avoids jargon so as to be understandable by the average retail investor, drawn up in a common format, completely standalone and distinct from other marketing material. It must be written in the official language (or one of the official languages) of the Member State where the PRIP is being sold.
The essential information to be included in a KID is the identity of the product and its manufacturer, the nature and main features of the product (including whether the investor might lose capital), its risk and reward profile, costs, and past performance (where applicable), any applicable compensation or guarantee schemes and then other information necessary for specific products. For complex PRIIPs, a “comprehension alert” is to be included in the KID (namely that the investor is about to buy a complex product which may be difficult to understand). All information is to be kept at a minimum to avoid the KID being too lengthy. The sequence of sections is prescribed to encourage comparability.
It is being left to the Level 2 measures to prescribe the exact wording, sections, format, of the KID including disclosures of risks and costs for specific types of PRIIPs.
It is not required to be provided to any investor other than retail investors. It is interesting to note here the changes that MiFID 2 is making to the classification of a ‘retail investor’ which will potentially mean that a wider set of investors will need to be provided with the KID.
Who is responsible for preparing and providing the KID?
Similar to the UCITS regime, the responsibility for preparing the KID rests with the product manufacturer or remanufacturer (e.g. where a financial intermediary substantively changes the risk or cost structure of an existing investment product).
The responsibility for providing the KID is on the entity advising or selling the PRIIP (i.e. the distributor / financial intermediary, if there is one). Where the product provider sells directly to retail clients, the responsibility will be on the product provider itself. Where a discretionary manager invests in a PRIIP for a retail client account, the obligation is satisfied by providing the KID to the discretionary manger.
Note here that similar to the UCITS regime, the KID must be provided to retail investors rather than simply being made available.
Medium used to make the disclosure
The recitals to the KID Regulation provide that all PRIIP manufacturers will need to publish the KID on their websites. Therefore, product providers will need to set up dedicated KID websites to host the library of KIDs for their PRIIPs.
The KID can be provided in paper (which is the default option) or in another durable medium. It can be provided through the use of a website where various conditions are met. It may be difficult for providers to satisfy these website conditions when dealing with retail clients.
The detail on the method and conditions for providing disclosure is intended to be further developed in Level 2 measures.
Timing of disclosure
The disclosure must be made ‘in good time’ before concluding a transaction in a PRIIP. Similar to the UCITS regime, there is again, no clarity on what ‘in good time’ means. There is some flexibility in the timing of disclosure for non-face-to-face distribution. The detail on the timing for providing disclosure is intended to be further developed in Level 2 measures.
Updating the KID
The information in the KID must be kept up-to-date which envisages frequent review of the KID and updated disclosure where there has been a change to the PRIIP or otherwise. The detail on the frequency of the review and the conditions for updating disclosure are to be further developed in Level 2 measures.
Other marketing material
The KID needs to be completely standalone and separate from any marketing material. Limited cross-referring to other documents is permitted. However, all other marketing material must indicate that a KID is available and signpost how and where it can be obtained including from the manufacturer’s website.
I also have UCITS, what should I be disclosing?
For UCITS, the UCITS KIID will continue to be the applicable disclosure document. However, given the desire for consistency in disclosure, it is intended that eventually the UCITS KIID will need to be aligned to the KID – whether this means replacing the UCITS KIID with the KID, or amending the UCITS KIID to be the same as the KID, it has not yet been decided. There is a transitional period of 5 years before the disclosure requirements for UCITS are intended to be considered.
What has been controversial?
Meaningful representation of risks and return
One of the most controversial aspects of the KID Regulation is how the complex structures that can sit behind packaged / structured products and their opacity can be broken down and explained in order to show their true likely return and risks. It is being left to the Level 2 measures to determine how risks and costs and returns can be disclosed in a consistent manner.
Standardisation of disclosure
Given the vast array of products that are caught by the KID Regulation, it has been questionable whether standardisation of disclosure can be achieved in any meaningful way and, if so, whether the KID will be helpful or whether it will further confuse retail investors.
Impact on the UK market
The KID Regulation has been particularly controversial in the UK and there was intense lobbying from the UK together with public comments from the regulator, the FCA. In the UK, almost all of the products that fall within the definition of being a PRIIP also come within the UK’s definition of a ‘retail investment product’ which is already caught by a disclosure regime, namely under the UK’s Retail Distribution Review (RDR). Under the UK’s RDR, there has been a complete separation from what a retail client pays for the advice they receive compared to what charges are associated with the product. The former charges (the adviser charges) must be disclosed before a service is provided to retail clients. The KID requires that all charges associated with the product are disclosed in the KID, this includes any adviser charges, and further that all advisers must provide the KID when advising on a PRIIP. This requirement therefore links the advice with a product in a manner which the FCA has taken great steps to separate in the RDR. It will be interesting to see the extent to which the UK seeks to retain the RDR requirements of disclosing adviser charging structures and also implement the KID for packaged retail investment products. As the KID Regulation is directly applicable, the FCA will have limited ability to provide guidance. Notwithstanding this point some market players have stated that they expect commentary from the FCA in relation to disclosing the adviser charges in the KID.
Liability and Sanctions
Controversially, but with the need to ensure that liability and the right to seek compensation is harmonised across the EU, the KID Regulation places the burden on the product provider / manufacturer to show that they have complied with the regulation where a retail investor makes a claim. Specifically, manufacturers / remanufacturers are intended to be held liable where a retail client suffers loss as a result of (1) the KID being inconsistent with binding pre-contractual or contractual documentation, (2) where the KID is misleading or inaccurate or (3) where the KID does not comply with the required form and content requirements as set out in the KID Regulation. Civil liability of a manufacturer in relation to the KID will remain a matter of national law.
With the intention to include a common glossary of terms and on requirements relating to the use of plain language, it is likely to be challenging for product manufacturers / remanufacturers to find a balance which satisfies the intention behind the KID Regulation while at the same time ensuring they are protected in the event of a retail investor claim.
Sanctions for breaching the KID Regulation will remain at national level, however, the EU intends that any breaches (and subsequent sanctions taken) should be made public to ensure that sanctions have a dissuasive effect and to strengthen investor protection.
The KID Regulation requires Member States to have the ability to prohibit or suspend the marketing of a PRIIP. The FCA already has this power in the UK.
With the EU introducing the ability to ban financial products on an EU wide basis in the MiFID 2 package, the KID Regulation introduces a similar ability for insurance-based investment products to be banned or restricted.
So what does this mean for me as a product provider?
Within the short transitional period (see below), manufacturers / remanufacturers will need to undertake an enormous amount of work namely:
- produce KIDs for all PRIIPs they produce, fully compliant with the KID Regulation;
- set up dedicated KID websites where the library of KIDs will be contained in order for distributors to be able to provide them to retail clients – this has particular unique challenges in order to satisfy the website conditions;
- ensure it is clear between themselves and their distributors who has the responsibility for providing the KID to retail investors;
- include structured deposits within their RDR regulatory net. As the UK’s RDR front-ran the EU’s proposals in MiFID 2 and the KID Regulation, the FCA stated that it would keep the definition of a ‘retail investment product’ under review and ensure it is aligned with the definition in the KID Regulation of a PRIIP. Therefore, an amendment to the definition of a ‘retail investment product’ in the UK is expected to include structured deposits.
So what does this mean for me as a distributor/adviser?
As well as including structured deposits within the RDR regulatory net (see above), distributors and advisers will need to:
- ensure that where they have the obligation to provide the KID, that the product providers have KIDs available for them and that any hyperlinks to KID websites work;
- ensure that where the distributor / adviser considers they are not responsible for providing the KID (because they act as agent for the product provider), that this is reflected in their distribution arrangements.
Once passed by the Council, the KID Regulation will enter into force 20 days after its publication in the Official Journal which, at the date of this article, has yet to occur.
There is a transitional period of two years from the entry into force of the KID Regulation before all the requirements will need to be complied with.
Level 2 measures
The KID Regulation sets the overall principles on the approach and content. The proposed Level 2 measures will standardise the presentation of the information and adapt the measures for specific features of other retail investment products.
Interaction with existing EU disclosure requirements
It is intended that the KID will sit alongside the summary requirements under the Prospectus Directive, the disclosure requirements under Solvency II, the requirements under the Distance Marketing of Consumer Financial Services and the e-commerce Directive.
It is intended that the KID Regulation will be reviewed within four years to assess its impact and whether the scope should be widened to other products.