The European Commission has recently published its long-awaited proposals on the regulation of Packaged Retail Investment Products (PRIPs). The aim of the initiative is to close gaps and inconsistencies in current rules across Europe, by introducing a horizontal approach to the regulation of mandatory pre-contractual product disclosures and sales practices for PRIPs.
Which products fall within the scope of the reforms?
The Commission has proposed a wide definition of PRIPs which would cover any "product where the amount payable to the investor is exposed to fluctuations in the market value of assets or payouts from assets, through a combination or wrapping of those assets, or other mechanisms than a direct holding". The definition focuses on economic effect, so as to maintain the focus on packaged investments.
The definition would capture all: investment funds, structured products in any form (eg, those packaged as insurance policies, funds or securities) including structured deposits (of which two alternative definitions have been proposed), and derivative instruments. Directly held products such as vanilla shares and bonds would not fall within the scope of the PRIPs definition. Nor would pure protection insurance and other insurance products, whose surrender value is not affected by market fluctuations.
iThe following products would be expressly excluded from the definition:
- Deposits which pay simple interest.
- Pensions, pending the Commission's review of the European pensions market. The Commission is consulting on whether investments packaged as variable annuities should be included within the PRIPs definition.
The Commission has proposed to supplement the definition with an "indicative list" of products falling within the regime, which would provide welcome clarity. However, given that the list would only be indicative, where a particular product type is not included in the list, there would be no certainty as to whether that particular product should or should not be treated as a PRIP.
The Commission may supplement the list with technical standards and guidance, which would also be welcome. The Commission may however seek to draft the list and guidance widely, so as to avoid products being developed in such a way as to avoid being captured within the definition.
How will pre-contractual product disclosures be regulated?
Currently, pre-contractual product disclosures are regulated pursuant to a number of different European Directives, including the Prospectus Directive (PD), the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive, the Solvency II Directive, the Insurance Mediation Directive (IMD) and the Markets in Financial Instruments Directive (MiFID). Rather than aligning the content of each Directive, the Commission intends to develop a separate piece of legislation to regulate pre-contractual disclosures. Technical standards and/or implementing legislation would then contain more detailed requirements for specific types of PRIPs, for example, in order to tailor disclosure requirements for different product classes. Duplicative requirements in existing legislation would be removed, so as to avoid confusion.
The new PRIPs disclosure regime would adopt the same principles as the UCITS Directive's Key Investor Information Document (KIID). The aim is to assist retail investors' decision making, by providing them with key, information in a streamlined form on a timely basis. The Commission acknowledges that it will not be possible to standardise disclosures, given the degree of variation between different types of PRIPs. However, a common approach will be taken to certain information, namely as to costs, risks, performance and guarantees.
Who will be responsible for producing the disclosure document?
Two alternative approaches are being consulted on. The first option is to place sole responsibility on the product manufacturer. The second, more flexible option, involves responsibility not being explicitly assigned, with perhaps the product manufacturer and distributor agreeing responsibility contractually. The Commission prefers the first approach. However, it acknowledges that in certain cases a distributor may be permitted to assume responsibility (for example where the manufacturer is unable or unwilling to produce the KIID).
Should the first option be pursued, clarity will be required as to exactly when the product manufacturer would be required to produce the KIID. This would be particularly important where a product has not been manufactured with retail investors in mind, but may ultimately be sold to retail investors by distributors. In this situation it would clearly be more appropriate for the distributors to be responsible for producing the KIID.
How will the Commission deal with changes to the regulation of sales practices?
A different approach is intended to address inconsistencies in the regulation of sales practices. The Commission wishes to align the content of the relevant directives, namely MiFID and the IMD, rather than introduce a new piece of legislation. The new rules will be addressed and consulted on during the course of the Commission's review of MiFID and the IMD.
In summary, the Commission intends to:
- MiFID: extend the application of the sales rules to PRIPs that are not currently covered (ie, deposit-based PRIPs) and to ensure these rules apply to sales of all PRIPs.
- IMD: introduce rules which are consistent with the MiFID rules on conflicts of interest and conduct of business.
- UCITS: make amendments to ensure direct sales by UCITS asset managers are subject to the MiFID sales rules.
How do the Commission's reforms sit with the FSA's Retail Distribution Review (RDR)?
The FSA had originally stated that its RDR proposals were compatible with the Commission's reforms (PS09/18, para. 1.9). However, in a subsequent policy statement it acknowledged that changes to the rules might be necessary once the outcome of the European reforms were known (PS10/6, para. 1.26). It is not clear whether a gap analysis has been performed. One obvious area of divergence is with regard to structured deposits, which will be caught by the PRIPs regime, but are outside the scope of the RDR.
What are the key stages?
The key stages are set out below. The Commission's timetable may well be impacted depending on the progress of the MiFID and IMD review.
- 31 January 2011: deadline for comments
- Q2 2011: product disclosure rules expected
- Q4 2011: sales practices rules expected
- By end 2011: European Commission aiming to complete legislative work