The EU regulation on key information documents (KIDs) for packaged retail and insurance-based products (PRIIPs) took direct effect in the European Union on 1 January 2018. This LawFlash outlines at a high level the circumstances in which the requirements of the regulation (PRIIPs Regulation) apply and is particularly relevant to EEA and non-EEA manufacturers and distributors of financial products when recommending, selling, or making financial products available to investors in the EEA.
What does the PRIIPs Regulation require?
The PRIIPs Regulation (1286/2014/EU) applies to PRIIPs that are made available, sold, or recommended to “retail investors” in the European Economic Area (EEA.) Broadly, it requires a three-page KID to be produced and provided to EEA retail investors in good time before they enter into a contract for a PRIIP. The KID is intended to inform investors and enable them to make comparative assessments of products which qualify as PRIIPs.
There are prescriptive format and content requirements for the KID that can be burdensome. For instance, the KID must contain specific details on the risks, performance scenarios (based on historic performance), and direct and indirect costs of the PRIIP in a standardised way and based on complex formulae. The UK Financial Conduct Authority has acknowledged concerns of PRIIPs manufacturers that in certain circumstances, the performance scenarios can be misleading.
What is a PRIIP?
PRIIPs include investments where the amount repayable to the retail investor is subject to fluctuation because of exposure to reference values or to the performance of one or more assets which are not directly purchased by the retail investor. Amongst other things, PRIIPs can include
- investment funds;
- derivatives (options, futures, and contracts for differences);
- securitisation vehicles;
- structured products;
- structured deposits; and
- debt instruments, where the principal repayable is subject to fluctuation because of exposure to reference values or to the performance of one or more assets which are not directly acquired.
Assets that are held directly, such as corporate shares or sovereign bonds, are not PRIIPs and are excluded from the scope of the PRIIPs Regulation.
Who needs to produce and provide the KID?
The PRIIPs Regulation applies to
- PRIIP “manufacturers”, i.e., entities that manufacture a PRIIP or make changes to an existing PRIIP, such as altering its risk and reward profile or its associated costs (e.g. fund managers, banks, investment firms, and insurance companies); and
- persons advising on or selling a PRIIP (e.g. placement agents and other distributors).
Before a PRIIP is made available to EEA retail investors, the PRIIP manufacturer must draw up for that PRIIP a KID in accordance with prescriptive requirements and must publish it on its website. It must review the KID regularly and promptly make any necessary revisions.
A person advising on or selling a PRIIP must provide the KID to EEA retail investors in good time before the investors are bound by any contract or offer relating to that PRIIP.
Who are “retail investors”?
A retail investor for the purpose of the PRIIPs Regulation is anyone who is not a “per se professional client”, or opted up to professional investor status, under MIFID. To opt up to MIFID professional status, a qualitative and quantitative test under MIFID must be satisfied.
Broadly, a “per se” professional investor is an investor who possesses the experience, knowledge, and expertise to make its own investment decisions and properly assess the risks. This includes, for example, banks, private investment funds (and their managers), pension funds (and their managers), hedge funds, broker dealers, insurance companies, large undertakings meeting certain requirements, and other institutional investors whose main activity is to invest in financial instruments.
Investors who can be treated as non-retail for local purposes in some countries under broader non-retail tests than the MIFID test may nonetheless qualify as retail investors for MIFID purposes and trigger the requirement to produce a KID. For example, the test for professional investor status for activities such as fund promotion in the UK, which is not MIFID business, is broader than the test under MIFID. This means that investors can be professional for UK purposes but yet classified as retail for MIFID purposes, which presents a potential trap for the unwary. “Exempt” retail investors, to whom certain products that are not available to ordinary retail investors can be promoted (e.g. high net worth and sophisticated individual investors in the United Kingdom and “semi-professional investors” in Germany) will need to be capable of being opted up to professional status under the MIFID test if the issuer wishes to avoid the requirement to produce a KID.
Entering into a mandate to provide investment services to a retail client (e.g. dealing or investment management services) will not require a KID. However, if the mandate to provide investment services relates to products which qualify as PRIIPs (e.g. advice on or dealing in relation to investment funds or derivatives), then a KID will need to be produced in relation to those funds and/or derivatives.
In order to avoid the requirement to produce a KID, products made available, recommended, or sold to investors in the EEA will need to be restricted to investors who qualify as professional investors (either per se or elective) under the MIFID test and selling materials and offering documents should contain appropriate disclaimers and notices to make that restriction clear.
Products made available on secondary markets
According to industry guidance, any PRIIP that is available on a secondary market, such as an exchange or securities market, is “made available” to retail investors and will require a KID. Further, the recitals to the PRIIPs Regulation says that the obligations on drawing up, and the rules on revision of, the KID should continue to apply for as long as the PRIIP is traded on secondary markets. However, it may be possible to structure a PRIIP traded in a secondary market so that it is clearly marked as not being for EEA retail investors.
A manager or sponsor of a fund maintaining an admission to trading or a listing on a securities market in the EEA could be making that fund available to EEA retail investors for the purpose of the PRIIPs Regulation and so it may have to produce a KID.
EU Commission guidelines state that the PRIIPs Regulation applies to non-EEA PRIIP manufacturers and non-EEA persons advising on or selling PRIIPs made available to EEA retail investors. Where EEA retail investors decide to purchase non-EEA PRIIPs, a person advising on or selling those PRIIPs must provide the retail investors with a KID. Further, any EEA intermediary will be required to provide EEA retail investors with a KID in relation to a non-EEA PRIIP and so would request this from the non-EEA manufacturer.