Revisiting distribution

The European Commission is concerned that the level of retail investor participation in EU capital markets remains very low compared to other economies, despite high individual savings rates. It is consulting (PDF 759 KB) until 3 August on a Retail Investment Strategy, which offers an opportunity for industry to comment on retail distribution across the piece. The debate is taking place against a backdrop of increased digitalisation of distribution. ESMA's Call for Evidence (PDF 301 KB) on digital finance seeks views on the use of digital platforms in the EU and the extent to which they introduce new risks or create regulatory and supervisory challenges. The Commission has proposed a European Digital Identity Wallet, which will store individuals' personal information and could be used by firms to carry out customer checks before offering financial services or products.

Meanwhile, ESMA has published final guidelines (PDF 431 KB) on marketing communications under the regulation on cross-border distribution of funds, which covers both UCITS and AIFs. And the long-running story on fund disclosure documents continues to play out, with new rules for PRIIP KIDs, differing approaches to the transition of UCITS KIIDs and further rule changes expected. Fund managers may need to contend with multiple and conflicting implementation deadlines, at the same time as introducing additional sustainability disclosures for products.

More detail is provided below. For further thoughts on the broad topic of distribution, look out for our Evolving Asset Management Regulation flagship report.

The Commission is expected to publish towards the end of 2021 the findings of research on disclosure, inducements and suitability rules for retail investors. The research includes consumer testing and mystery shopping, as well as desktop legislative analysis and interviews with industry. The findings, together with responses to the current consultation, will inform the final strategy, to be published in the first half of 2022.

In the consultation document, the Commission observes that investor protection rules are spread across different sector-specific legislation and are inconsistent. The cumulative requirements on disclosures can lead to information overload or leave out important information. Financial advice may be biased towards products with higher inducement payments, which raises questions about the effectiveness of the suitability assessment. The Commission says that individual investors should benefit from:

• Adequate protection
• Bias-free advice and fair treatment
• Open markets with a variety of competitive and cost-efficient financial services and products
• Transparent, comparable and understandable product information

The Commission also notes that EU legislation should be forward-looking and should reflect ongoing developments in digitalisation and sustainability, as well as the increasing need for retirement savings. The consultation is therefore wide-ranging and covers various rules impacting fund distribution, including MiFID II, UCITS, the Insurance Distribution Directive (IDD), the PRIIP KID and the pan-European Personal Pension Product (PEPP).

The Commission seeks views on which area (or areas) might most be improved in order to increase the protection of investors, which factors discourage or prevent retail investors from investing, and the characteristics of products available to EU retail investors (such as whether they are accessible, understandable, comparable and competitively priced).

The detailed questions indicate a revisiting of key principles:

• A horizontal review of existing disclosure documents as regards product understanding and comparison, which will include disclosures in digital form
• Suitability assessment and appropriateness
• Investor categorisation, to ensure more tailored safeguards and to reduce the administrative burden
• Increased transparency around inducements and further limiting them, to ensure retail investors receive non-biased, high-quality, reliable and fair advice
• Potential certification requirements and a pan-European quality label for financial advisers
• Distinguishing between simple, transparent and cost-efficient products versus “complex” products
• How better to protect retail investors against speculative bubbles in an increasingly digital environment

Other topics covered include financial literacy, redress and ESMA's product intervention powers.

As part of its wider work on digital finance, the Commission mandated the ESAs to provide technical advice by end-January 2022 on:

1. Fragmented or non-integrated value chains and growing reliance by regulated firms on third parties
2. Platforms and the bundling of various financial services
3. Groups combining different activities

ESMA's Call for Evidence, which will inform its response to the Commission and has a response deadline of end-July, notes that the different financial services bundled on a platform may fall under separate sectorial regulations or outside the scope of the EU financial services regulatory perimeter. This can leave certain risks unaddressed and raise specific supervisory challenges. ESMA therefore suggests a holistic approach to the regulation and supervision of platforms and bundled services, including rules on interactions with consumers, conduct of business, money laundering and operational risk.

Meanwhile, the Commission will do further work on its proposed Digital Identity Wallet and has invited Member States to establish a common toolbox by September 2022 and to start the necessary preparatory work immediately. The toolbox will include the technical architecture, standards and guidelines for best practices.

ESMA's final Guidelines on marketing communications under the Regulation on cross-border distribution of funds take into consideration feedback to its November 2020 consultation, including that the draft Guidelines should be amended to facilitate online marketing. ESMA has also taken on board industry concerns that the draft suggested fund managers should be responsible for ensuring that marketing communications issued by third-party distributors meet the requirements.

The purpose of the Guidelines is to promote convergence on the identification of marketing communications and description of risks and rewards, as well as ensuring fair, clear and non-misleading communications. The publication of the Guidelines in the various languages will trigger a two-month period during which national regulators must notify ESMA whether they comply or intend to comply with the Guidelines (i.e. whether they impose the Guidelines on regulated firms).

The Commission has confirmed that it intends to endorse the revisions to the PRIIP KID regulation proposed by the ESAs, which will come into force mid-2022. The Commission will also extend the UCITS exemption by six months, from end-2021 to mid-2022. However, various deadlines remain out of sync:

• UCITS managers will need to do the annual review of KIIDs early in 2022, only a few months ahead of the switch to the new PRIIP KID.
• Absent a further legislative amendment, insurance products with funds as the underlying investment options will not be able to use UCITS KIID data after end-2021, even though UCITS KIIDs will still exist.
• The UK government intends to legislate for an extension to the current PRIIPs exemption for UCITS for five years, to end-2026, while it undertakes a review of the UK retail disclosure regime. In practice, the FCA will introduce rule changes within that timeframe, but there is likely to be a disconnect with both the EU rules and the mid-2022 deadline. Meanwhile, UK closed-ended funds will have to continue to issue PRIIP KIDs with potentially misleading performance scenarios.

Given that a broader review of the PRIIP KID is part of the Commission's consultation on the EU Retail Investment Strategy, further changes to fund disclosure documents may be expected, perhaps as early as 2023.