MiFID III arrives as the Retail Investment Package is unveiled

Sometimes you know something is coming but still remain surprised as to the potential consequences. This is one of those occasions. In our view, this is "MiFID III" ("this time it's retail"). That said, the changes it will bring are not solely ring-fenced to retail customers.

On 24 May 2023, the European Commission published its Retail Investment Package. This follows the September 2020 Capital Markets Union Action Plan, where the Commission announced its intention to put forward a strategy for retail investments in Europe. The package has also been foreshadowed in a number of speeches by EU officials.

It is huge. Amongst other things, it proposes banning inducements/commissions on certain execution only sales of investment products and will also lead to significant changes in organisational arrangements for investment firms. The "inducements ban" may have untold consequences that we doubt have been fully considered. The package also introduces measures concerning suitability assessments and marketing communications (among others). It will also change the way in which EU "passporting" works in practice (with increased requirements where EU customers are involved).

For those who have been following the Consumer Duty in the UK, there are some similar themes in this EU package however this is far more intrusive and rules-based. We take a look at the key aspects below.

Why has this package been introduced? 

The package is designed to address perceived shortcomings in the current EU regulatory framework for retail investment, namely that retail investors struggle to access relevant, comparable, and easily understandable information to make informed investment choices, as well as shortcomings in the way products are designed and distributed. The European Commission also notes that some investment products do not offer value for money (in language similar to the FCA's incoming Consumer Duty).

What exactly is the package?

The scope includes MiFID financial instruments, such as structured products and related instruments but is also wider.

The proposals are set out in a so-called Omnibus Directive (and Annexes) amending MiFID, the IDD, Solvency II, UCITS and AIFMD. Alongside the so-called Omnibus Directive, the European Commission has published a proposed Regulation amending the existing Regulation on key information documents for packaged retail and insurance-based investment products.

What is the value for money reference / requirement?

It is important and will lead to amendments to current product governance processes. Firms will need to incorporate a more granular analysis of costs and charges into their current architecture.

The package builds on previous work by EIOPA and ESMA on enhancing product governance rules (e.g. MiFID Product Governance), including rules on pricing processes to ensure that products that are offered to retail clients offer good value for money for retail investors (see our briefing here). The existing rule under MIFID stating that financial products are only manufactured and/or distributed when they provide value for money will be supplemented with a new requirement on manufacturers to set out a "pricing process" allowing for the identification and quantification of all product costs and charges, and an assessment of whether such costs and charges undermine the value which is expected to be brought by the product. Distributors will also be required to carry out similar assessments (building on the assessment of the manufacturers, they will be expected to take into consideration overall costs incurred by retail investors when purchasing a product).

ESMA has also been given a mandate to develop, make publicly available, and regularly update cost and performance benchmarks against which manufacturers and distributors must compare their products prior to offering them on the market.

In addition, there will be a requirement for investment firms to provide all retail clients and customers with an annual statement providing, among other things, information on costs and charges, including third party payments and performance. Depending on the investment products offered, there will be minimum information requirements to be included in the annual statement.

What about inducements?

In relation to MiFID, the Commission proposes a ban on inducements paid from manufacturers to distributors in relation to the reception and transmission of orders, or the execution of orders to or on the behalf of retail clients (investment services covering execution-only sales where no advice relationship exists between the investment firm and the client). This is in addition to the existing ban on inducements concerning independent advice and portfolio management. This is noteworthy for manufacturers/issuers who provide products via execution only distribution chains (which, in certain, asset classes has increased in recent years). Notably, the inducement ban does not apply to fees or any other remuneration received from or paid to an issuer by an investment firm performing for the issuer services of placement or underwriting where the investment firm also provides to retail clients reception and transmission of orders or execution services. This will be welcomed in Spain where this issue has been discussed by stakeholders and by the CNMV.

In relation to sales where advice is provided, it is proposed that the current criteria be replaced with a new uniform test requiring advisors to act in the best interest of the client.

Is anything being done about "finfluencers" and marketing communications in general?

The package introduces a number of measures designed to enhance existing requirements concerning marketing communications (new definitions to be added to MIFID in relation to "marketing communications" and "marketing practice").

These include requirements that: marketing communications are identifiable and are appropriately attributed to the investment firm by which or on whose behalf they are made; essential characteristics of the investment product or service are clearly presented in all marketing communications; and marketing communications and practices are developed, designed and provided in a manner which is fair, clear and not misleading, and are balanced in their presentation of risks and benefits as well as appropriate for the target group of investors they are aimed at.

The proposal also includes a requirement for investment firms to have a policy on marketing communications and practices (the investment firm's management body will be expected to define, approve and oversee). Existing record keeping obligations under MiFID are to be extended to cover all marketing communications which are directly or indirectly made by the investment firms. Investment firms would be expected to keep records for a period of five years and, where requested by the competent authority, for a period of up to seven years.

Anything on appropriateness and suitability?

Yes, amendments will be needed to firms' appropriateness and suitability documentation.

The package makes amendments to the existing requirements that distributors comply with when assessing the suitability of a recommendation or the appropriateness of a financial product and these include proposals that: investment firms explain the purpose of the assessments to clients and customers in a clear and simple way, and obtain all relevant information from clients and customers which may be necessary and proportionate for the assessments (and a proposal that retail investors need to be informed, via standardised warnings, about the consequences on the quality of the assessment if they do not provide accurate and complete information); suitability and appropriateness assessments will need to be undertaken in good time before the relevant investment service is provided or before the customer is bound; and a suitability assessment report will need to be provided to clients/customers sufficiently in advance before the conclusion of the transaction to enable clients to seek and get additional clarifications where needed.

The need for portfolio diversification has been added as one of the factors that distributors need to assess when considering the suitability of a specific product or service on the basis of information obtained from the client or customer, including information on any existing portfolios. For appropriateness tests, the information that intermediaries need to obtain and assess in respect of retail clients is expanded to also include the ability to bear full or partial losses and risk tolerance.

What about client categorisation?

The European Commission includes proposed amendments to Annex II of MiFID, which sets out the criteria for determining whether a client can be treated as professional on request. The amendments include a reduction of the wealth criterion from EUR 500 000 to EUR 250 000, and the inclusion of a possible fourth criterion concerning the relevant education/training. The proposed amendments also create the possibility for legal entities to qualify as professional on request by fulfilling certain balance sheet, net turnover and own funds criteria.

What are the main changes to the Packaged Retail and Insurance-based Investment Products (PRIIPs Regulation)?

The proposed Regulation seeks to adapt disclosures to the digital environment and to provide further clarity on the scope of PRIIPs in relation to corporate bonds with make-whole clauses and immediate annuities. Changes include increased flexibility in the use of electronic formats so as to improve the presentation of the PRIIPs KID through the use of layering (i.e. allowing for clicking on the titles of different sections of the KID and expanding the text in the sections of interest). The three-page KID would still need to be drawn up in accordance with Article 8 of the PRIIPs Regulation and be available on the manufacturer's website.

So as to make information on sustainability-related characteristics of investment products more comparable, a new section in the PRIIPs KIDs titled "How environmentally sustainable is this product?" is to be introduced. This information would be taken from the disclosures provided by product manufacturers pursuant to the SFDR and associated legislation.

What happens next?

In accordance with the ordinary legislative procedure, both sets of legislation will now be considered by EU co-legislators (the Council of the EU and the European Parliament). This process is expected to take at least a year, and could be impacted by forthcoming European Parliament elections in June 2024.

Both sets of legislation state that they will enter into force 20 days following publication in the Official Journal. The Omnibus Directive states that Member States must adopt and publish transposition measures necessary to comply with the Directive 12 months from entry into force and must apply the provisions 18 months after the entry into force. The proposed Regulation is to apply 18 months after the entry into force date.

The package also includes provisions for European Supervisory Authorities (such as ESMA) to produce delegated acts setting out further detail (e.g. the methodology for a benchmark). It may therefore take some time to understand the full impact of this Strategy.

Co-author: Bisola Williams