As the “most ambitious legislative proposal since the inception of EU financial regulation”, the changes would make significant amendments to MiFID II and PRIIPs.
On 24 May 2023, the European Commission (Commission) published a package of proposals to strengthen protections for retail investors within the European Union (EU) and place “consumers’ interests at the centre of retail investing”. The proposals significantly amend the protections afforded to retail clients under MiFID II, and also impact the institutional markets, as discussed below.
Reflecting on the context of these proposals, the Commission remarks that the “problems” associated with retail investing include a lack of access to relevant, comparable, and easily understandable information; financial advice that is not always in the retail investor’s best interests; undue influence by marketing (particularly on social media); and some investment products that do not offer value for money. The proposal’s stated aim is to improve the framework so that consumers are empowered to make retail investment decisions and to increase trust in EU capital markets.
As far back as 2020, the Commission set out in the 2020 Capital Markets Union Action Plan that a long-term goal was to make the EU a safer environment for citizens to invest, whilst at the same time encouraging participation in the EU capital markets. In announcing the proposals, Mairead McGuinness, Commissioner for Financial Services, stated, “This is the most ambitious legislative proposal since the inception of EU financial regulation. It aims to ensure that the financial framework works in the interest of retail investors”.
As the UK looks to shake up its own regulatory regime through the Edinburgh Reforms (please see Latham’s previous blog post on this topic) and the Financial Services and Markets Bill, these proposals serve as an important illustration of Brexit divergence in practice. Firms with operations spanning the UK and EU will need to follow the reforms closely to understand what changes they will be required to make to policies and procedures in each jurisdiction.
Referred to as the Omnibus Directive, the proposals are wide-ranging in the sense that they contain amendments to numerous EU regulatory regimes that have a touchpoint with retail investors, including MiFID, the UCITS Directive, AIFMD, the IDD, and Solvency II. A separate regulation would also amend the PRIIPs Regulation. Details of the key changes are set out below.
Inducements and the Best Interests Test
Having considered the introduction of a complete ban on inducements, the proposals land on an inducements ban for execution only and receipt and transmission services provided to retail clients. There would be an exception for minor non-monetary benefits of a total value below €100 per annum, or that could not be judged to impair compliance with the investment firm’s duty to act in the best interest of the client, provided these benefits are clearly disclosed.
The existing ban on inducements relating to portfolio management and independent advisory services would remain in place, although the new indicative €100-per-annum threshold for minor non-monetary benefits would also apply in respect of this ban. This means that there would be no ban on inducements for non-independent advice. However, there would need to be enhanced disclosures to retail investors explaining the difference between independent and non-independent advice and potential conflicts of interests. The Commission has included a review clause in the proposals, meaning this topic will be reconsidered in three years. The UK already has a broader ban on inducements than that required by MiFID II, as it carried across pre-existing rules that banned inducements for firms providing non-independent advice to UK retail clients. The focus in the UK now is on considering revisions to the research unbundling rules (see Latham’s related blog post).
The Commission is also proposing to introduce stricter requirements for advised sales, including those in relation to which inducements are permitted. These requirements would replace the “quality enhancement” and “no detriment” tests in MiFID and the IDD. They would build out what is required in order to act in the best interest of clients, mandating that financial advisors: (i) base their advice on an assessment of an appropriate range of financial products; (ii) recommend the most cost-efficient financial product from the range of suitable financial products; and (iii) offer at least one financial product without additional features which are not necessary to achieve the client’s investment objectives such that retail investors can compare to alternative and possibly cheaper options.
Value for Money Concept
With the overall objective of strengthening product governance rules for retail investors, the Commission is proposing amendments to MiFID II and the IDD to introduce rules on pricing processes for PRIIPs to ensure that products offer good value for money. Similar rules would also be introduced in the AIFMD and UCITS Directive.
The requirements would apply to both manufacturers and distributors of retail investment products. They would need to set out a pricing process to allow for easy identification and quantification of all costs and charges, and assess whether such costs and charges undermine the product’s anticipated value.
ESMA and EIOPA would be required to develop and publish benchmarks based on data from manufacturers, distributors, and national regulators on product costs, charges, and performance. Manufacturers and distributors would need to compare their products to these benchmarks prior to offering them on the market. If the costs and performance of the product are not aligned to the benchmark, that product should not be marketed to retail investors until additional testing and further assessments have established that the product indeed offers value for money to the target market.
Notably, some parallels can certainly be drawn between the Value for Money concept that the Commission proposes and the price and value element of the new Consumer Duty that the FCA is introducing in the UK. While financial regulators do not have a role to play in regulating prices, clearly there are concerns that pricing methodologies do not always result in consumers receiving value for money.
The Commission has proposed amending Annex II of MiFID to ease restrictions to qualify as an elective professional client. The amendment would see the
wealth criterion revised downwards from €500,000 to €250,000, and the addition of a new criterion which takes into account the individual’s relevant training and education.
The Commission notes that “retail investors are exposed to a growing risk of being inappropriately influenced by unrealistic marketing information through digital channels and misleading marketing practices”.
The Omnibus Directive would introduce a number of provisions in MiFID II to regulate marketing communications, including a new definition of marketing communications and marketing practices. The proposals also include a requirement that firms have a policy on marketing communications and practices which should be defined, approved, and overseen by the board. To support this, firms would be required to implement systems and controls to ensure compliance with marketing communications obligations and practices. The Commission also proposes enhanced disclosure requirements for marketing materials to ensure that “essential information” about the firm and product is clear and readily accessible.
The Commission’s concerns about marketing practices on social media very much align with the FCA’s concerns in this area. In the UK, the FCA is looking to clamp down on illegal social media financial promotions by so-called “finfluencers” (please see Latham’s previous blog post for more information on this topic) and has been working to strengthen the financial promotion rules.
The Commission is seeking to make some targeted changes to the PRIIPs framework. This effort contrasts with the position in the UK, where the controversial regime is to be scrapped and replaced by a new UK retail disclosure framework. The Commission says that its proposals are designed to “build upon and improve existing rules that govern PRIIPs KIDs to retail investors by manufacturers and distributors of investment products but the main provisions of PRIIPs remain intact”.
The proposals seek to resolve some key areas of uncertainty, including:
- Confirming that retail products providing immediate annuities without a redemption phase are excluded from the PRIIPs Regulation
- Clarifying that certain types of corporate bonds with make-whole clauses are out of scope of the PRIIPs Regulation, provided they are redeemed at a fair value
- Amending the rules for presenting costs of multi-option products by specifying the conditions that have to be met so as to provide transparent information to retail investors
The Commission also intends to make the KID more accessible by:
- Introducing a new section in the KID called “Product at a glance”, summarising the information on the investment product, its costs, and level of risk
- Removing the “comprehension alert” at the start of the KID
- Including requirements to provide investors with ESG information setting out the environmental sustainability of the product
- Simplifying the provisions for making KIDs available, including establishing a strong preference that KIDs are to be provided in electronic format
Financial Literacy and Qualification of Financial Advisors
The Commission has also announced some complimentary measures to further protect retail investors, including mandating that Member States promote financial education at a national level, and strengthening and aligning the knowledge and competence requirements for financial advisors under MiFID II and the IDD. Requirements on knowledge and competence that currently sit in ESMA Guidelines would be brought into the MiFID II legislative framework, along with a new element regarding sustainable investments. There would also be a minimum requirement for ongoing professional training under MiFID, in line with requirements under the IDD.
Impact on Institutional
An interesting observation about this set of proposals is that despite being framed as retail focussed, the proposals go beyond retail in many instances and affect the institutional side. It is therefore certainly worth examining the suite of proposals closely through an institutional lens.
The examples below illustrate this point.
Distinction Between “Retail Clients” and “Clients”
For certain amendments, the Commission has drawn the distinction between “retail clients” and “clients” (the latter capturing both retail and institutional clients), and various changes apply in respect of all clients. For example in the proposed Article 24a of MiFID II on inducements, while the new ban applies in respect of business with retail clients only, other amendments to the pre-existing rules on inducements apply to both retail and institutional clients.
This is also the case in relation to the proposed Article 24b of MiFID II, which governs information on costs, associated charges, and third-party payments, and applies to all clients (with an opt-out for eligible counterparties). The proposals would move existing regulatory disclosure obligations under Article 24(4) to the new Article 24b and prescribe standardisation of such information. They would also require an explanation of the purpose of third-party payments and quantification of their impact on expected returns.
Research unbundling is almost entirely an institutional-related topic, and the proposals would permit “rebundling” in relation to research concerning issuers with a market capitalisation of €10 billion or less, significantly raised from the current threshold of €1 billion.
The proposals also include measures to strengthen ties between competent authorities when supervising cross-border activities. Proposed new Article 35a of MiFID II, which covers reporting of cross-border activities, would require annual reporting to the regulator in a firm’s home Member State if the firm provides investment services to more than 50 clients (retail or institutional) on a cross-border basis.
The Commission is inviting feedback on the legislative proposal by 26 July 2023, though this period may be extended. Following the feedback period, the proposals will be presented to the European Parliament and Council for a vote. Notably, this will happen against the backdrop of upcoming European Parliament elections in May 2024, which means further changes to the proposals are likely as extensive lobbying of EU lawmakers is a commonality of any proposed changes to EU legislation.
These proposals may take some time before to be finalised and come into effect, but firms active in the UK and EU will want to monitor areas of divergence closely and consider how to implement necessary changes across the business.