The European Commission (Commission), European Parliament and European Council have now reached agreement on the texts for the Recast Markets in Financial Instruments Directive (MiFID 2) and the Markets in Financial Instruments Regulation (MiFIR). Together, MiFID 2 and MiFIR comprise the MiFID 2 pieces of primary legislation. They are expected to come into force by the end of 2016.

In addition to the changes to the regime governing investment services and activities, MiFID 2 will amend the Insurance Mediation Directive 2002/92/EC (IMD) through the addition of Customer Protection Provisions governing the distribution of insurance-based investment products (IBI Products).

Why does the Commission think that changes to the regime governing IBI Products are necessary?

The Commission acknowledged the role of contracts of insurance made available to investors as potential alternatives or substitutes to the financial instruments governed by MiFID. A Recital to MiFID 2 declares that in order to deliver consistent protection for retail clients and ensure a level playing field between similar products, the investor protection requirements, which MiFID 2 introduces, should apply to “investmentspackaged under insurance contracts”.

Why has the Commission simply not expanded the scope of MiFID 2 to include IBI Products within the list of MiFID financial instruments?

The Recitals to MiFID 2 indicate the Commission’s view that, whereas the investor protection requirements in MiFID should be applied equally to IBI Products, their different market structures and product characteristics make it more appropriate that detailed requirements are set out in IMD 2 rather than in MiFID 2.

What is covered under the MiFID 2 definition of an IBI Product?

MiFID 2 defines an IBI Product as “an insurance product which offers a maturity or surrender value and where that maturity or surrender value is wholly or partially exposed, directly or indirectly, to market fluctuations”. This indicates that an IBI Product would need to include an investment component that is expected to provide a variable rate of return. This would be likely to cover IBI Products such as unit-linked and index linked contracts, fixed index annuities and variable annuities. (See also the Joint Forum final report on Point of Sale disclosure in the insurance, banking and securities sectors, published on 30 April 2014 (POS Report) Section III.3.)

What is excluded from the MiFID 2 definition of an IBI Product?

In addition to the non-life insurance products listed in Annex I to Directive 2009/138/EC (Solvency II), MiFID 2 excludes the following from the definition of an IBI Product:

  • life insurance contracts where the benefits under the contract are payable only on death or in respect of incapacity due to injury, sickness or infirmity
  • pension products which, under national law, are recognised as having the primary purpose of providing the investor with an income in retirement, and which entitles the investor to certain benefits
  • officially recognised occupational pension schemes falling under the scope of Occupational Pension Funds Directive 2003/41/EC or the Solvency II
  • individual pension products for which a financial contribution from the employer is required by national law and where the employer or the employee has no choice as to the pension product or provider.

Who will be subject to the Customer Protection Provisions?

The Customer Protection Provisions will apply both to insurance intermediaries (Intermediaries) and to insurance undertakings (Insurers).

Insurance mediation activities undertaken by an Insurer itself or an employee of the Insurer acting under that Insurer’s responsibility are currently excluded from the IMD. MiFID 2 will alter the scope of this exclusion with the effect that an Insurer or its employee(s) will be subject to the Customer Protection Provisions.

What activities will be subject to the Customer Protection Provisions?

The Customer Protection Provisions will apply to “insurance distribution activities”.

  • For Intermediaries, this means any insurance mediation activity carried on in relation to an IBI Product. Following the IMD definition of insurance mediation, this will include the following: (i) introducing, proposing or carrying out other work preparatory to the conclusion of a contract governing an IBI Product, (ii) concluding an IBI Product contract or (iii) assisting in the administration and performance of an IBI Product contract, in particular in the event of a claim.
  • For Insurers, this means any direct sales carried on in relation to an IBI Product.

What do the Customer Protection Provisions address?

The Customer Protection Provisions cover four broad areas: prevention of conflicts of interest, standards of conduct, information and inducements.

What types of conflicts of interest are covered under the Customer Protection Provisions?

The Customer Protection Provisions identify the following types of conflicts of interest:

  • conflicts between Intermediaries and Insurers themselves, including their managers, employees and tied Intermediaries, or any person directly or indirectly linked to them by control and their customers that arise in the course of carrying out any insurance distribution activities; and
  • conflicts between one customer of an Intermediary or Insurer and another customer that arise in the course of carrying out any insurance distribution activities.

MiFID 2 empowers the Commission to adopt measures establishing appropriate criteria for determining the types of conflict of interest whose existence may damage the interests of the customers or potential customers of the Intermediary or Insurer.

What are the requirements with respect to the prevention of conflicts of interest?

MiFID 2 will require Intermediaries and Insurers to maintain and operate effective organisational and administrative arrangements with a view to taking all reasonable steps to prevent conflicts of interest from adversely affecting the interests of its IBI Product customers.

What if Intermediaries and Insurers are unable to prevent conflicts of interest?

Where an Intermediary or Insurer is unable, with reasonable confidence, to prevent the risk of damage to an IBI Product customer’s interests, the Intermediary or Insurer will have to disclose clearly to the customer the general nature and/or sources of conflicts of interest before undertaking IBI Product business on the customer’s behalf.

MiFID 2 empowers the Commission to adopt measures defining the steps that Intermediaries or Insurers might reasonably be expected to take to identify, prevent, manage and disclose conflicts of interest when carrying out insurance distribution activities.

What standards of conduct will the Customer Protection Provisions require?

When carrying out insurance distribution activities, an Intermediary or Insurer will be required to act honestly, fairly and professionally in accordance with the best interests of its customers.

What information requirements will the Customer Protection Provisions impose?

An Intermediary or Insurer will need to ensure that all information, including marketing communications, addressed by the Intermediary or Insurer to IBI Product customers or potential customers is fair, clear and not misleading. The Intermediary or Insurer will also have to ensure that marketing communications are clearly identifiable as such.

What about inducements?

MiFID 2 will give Member States the power to prohibit the acceptance or receipt of fees, commissions or any monetary benefits paid or provided to Intermediaries or Insurers, by any third party or a person acting on behalf of a third party in relation to the distribution of IBI Products to customers.

To what extent are the Customer Protection Provisions the same as those for MiFID 2 financial instruments?

The provisions in Sections 1 and 2 of Chapter II of MiFID 2 are a lot more detailed and cover more than the prevention of conflicts of interest, standards of conduct, information and inducements. However, implementing IMD 2, Member States could look to the provisions in Sections 1 and 2 of Chapter II of MiFID 2 in developing a standard set of rules for all retail investors. The former UK investment services and insurance regulator, the Financial Services Authority (FSA), took a uniform approach to the distribution and other conduct of business requirements for investment products and various life insurance products. The UK Financial Conduct Authority has carried this approach forward. The provisions of its Conduct of Business Sourcebook (the majority of which the FSA made as part of the UK implementation of MiFID) apply both to “designated investment business” and “long-term insurance business in relation to life policies”. (See COBS 1.1.1.)

Are there any similarities between the Customer Protection Provisions and the conduct of business rules in IMD 2?

Yes. Article 15 introduces two general conduct of business principles. These require:

  • Intermediaries to "always act honestly, fairly, trustworthily, honourably and professionally in accordance with the best interests of its customers"
  • all information to be "fair, clear and not misleading" with all marketing communications to always be clearly identifiable as such.

Are there other EU or international initiatives where the distribution of insurance and investment products are being considered together?

Yes. The proposed Packaged Retail and Insurance-Based Investment Products (PRIIPs) Regulation on which agreement was reached on the same date as MiFID 2. The PRIIPs Regulation will govern the disclosure requirements for investment funds, insurance-based investment products and retail structured investment products. The PRIIPs Regulation will require the manufacturers of these products (and other firms who modify them) to draw up a key information document for retail investors which can be no longer than three pages in length and must be written in simple language. The PRIIPs Regulation sets out the framework for the required form and content of the document and the procedures for providing it to retail investors. The PRIIPs Regulation also introduces product intervention powers for insurance-based investment products, both at a Member State level and at a European level, which are comparable with equivalent powers under MiFID II.

What's next?

As the amendments made by MiFID 2 are to the IMD, the implementation of the Customer Protection Provisions will be determined by the IMD 2 implementation timetable. In this respect, the IMD 2 is currently expected to be implemented in 2014 and to come into force in 2016.