EU Retail Investment Strategy (RIS) View

It's here at last! The long-awaited (and much discussed) final version of the EU Commission's Retail Investment Strategy and Annexes (RIS) was published on 24 May 2023. It also includes related but separate document proposing minor amendments to PRIIPs Regulation (you can find our separate briefing here on that).

So, what does the RIS say? You can also watch a recording of our webinar on this too.

To ban or not to ban (inducements) ... that is the question

Let's start with one of the most controversial areas - inducements. At the end of 2022 into 2023 we saw open letters passed between EU Commissioner McGuinness and MEP Markus Faber arguing over whether the RIS should propose a ban on inducements. There was significant industry lobbying on both sides of that argument. The EU Commission toyed with the idea of bringing in a full ban on inducements for non-independent advice, as well as for execution-only and RTO. In the end they didn't go that far. The RIS proposes:

• No full inducements ban for non-independent advice. Welcome news to some, disappointing to others...but it's not a free-pass. Significantly, the Commission has not closed the door on this. A review clause allows it to revisit the topic in 3 years and make further proposals - including, potentially, a ban. We are also aware that there are groups within the European Parliament strongly advocating that a full ban should be introduced.
• An inducements ban for execution-only and RTO. There are some limited exceptions for underwriting/placement scenarios and when non-independent advice is combined with execution-only/RTO.
• The existing MiFID inducements 'quality enhancement' test is replaced with a new 3-fold 'best interest' principle requiring non-independent advisors to:
  • base their advice on an assessment of an appropriate range of financial products; and
  • recommend the most cost-efficient financial product from the range of suitable financial products; and
  • offer at least one financial product without additional features which are not necessary to the achievement of the client's investment objectives and that give rise to additional costs, so that retail investors are presented also with alternative and possibly cheaper options to consider. 'Additional features' might include a fund with an investment strategy which implies higher costs, a capital guarantee, or structured products with hedging elements.
• The minor non-monetary benefit threshold is set to EUR100 per annum.
• A change in wording from cannot 'accept and retain' to cannot 'pay or receive' inducements, for portfolio management as well as execution-only and RTO (although not for independent advice) meaning that, for example, clean share classes only would be permitted in these circumstances.
• Enhanced disclosuresto ensure retail investors understand the concept of inducements, potential conflicts of interest and overall costs and expected returns.

It's all about the (value for) money - pricing and benchmarking

The other much-talked about proposals are on product governance. Over recent months there has been market chatter that a value for money concept would be proposed by the Commission to allay fears that the price of retail products remains too high - and as an alternative to a full inducements ban for non-independent advice. This is exactly what we see in the RIS - via a new pricing process to be integrated into manufacturer and distributors product governance frameworks. The requirements appear to apply to PRIIPs (although the drafting is slightly unclear in places as to whether it could apply more broadly to financial instruments) as well as UCITS and AIFs. The intention is to limit the offer of products that bear poor or no value for money for retail investors. Firms will be required to make a comparison of the cost and performance of a product against wider benchmarks...and ESMA is requested to develop those benchmarks. Under the proposals there is a two-fold test:

• quantitative: products whose value aligns with the relevant benchmark can be offered to the retail market;
• qualitative: products whose value does not align with its benchmark should not be marketed to retail unless additional testing can show that it still offers value for money. Additional underlying legislation will be required to provide further detail on this process.

The proposals leave big questions. How will ESMA come up with these benchmarks? How 'tight' they will be on product parameters? How is it to be decided which benchmark aligns with which product? How long it will take to produce the benchmarks? How many benchmarks will there be? Is ESMA suitably qualified to do this? How exactly will the process work for firms carrying out pricing assessments in absence of a benchmark or if the benchmark is inadequate? Is this a move towards pricing interventionism?

The RIS also proposes additional changes to UCITS and AIFMD involving 'undue costs', which seek to enshrine and expand into main legislation ESMA's existing supervisory briefing requirements. One proposal of note is the requirement for AIFMs and UCITS Mancos to compensate investors if undue costs have been charged. There is not much meat on the bone on these requirements and further underlying legislation will be needed to provide the detail.

The more the merrier - expanded scope of elective professional client

In a move that will likely be welcomed by many, the criteria for MiFID retail clients to opt into professional client status has been widened. The wealth criteria has been reduced from EUR500,000 to EUR250,000. A new fourth option to the criteria has been added, allowing the education and training of the client to be taken into account. Finally legal entities can qualify by fulfiliing certain balance sheet, net turnover and own funds criteria.

Suitability-'lite'

One of the key anti-inducement ban arguments has been that independent advice is just too expensive for many retail investors - that the upfront costs are prohibitive - and that's why non-independent advice paid for through inducements should remain. In response to this, the RIS proposes that MiFID independent advisors should be allowed to advise retail clients on well-diversified, non-complex and cost-effective products based on a more limited set of data collected for the suitability assessment. A suitability-lite regime if you like. The stated intention of the Commission is that this will help develop an independent advice market that charges a reasonable cost, no longer making it too expensive for retail investors. Whilst a welcome proposal to many in the industry, sceptics may be left wondering if the Commission is dismantling the roadblocks for a potential future (re-)introduction of a full ban on inducements for non-independent advice.

Suitability and appropriateness

Added to the list of elements to consider in a suitability assessment is the need for portfolio diversification. The list of elements to be considered in an appropriateness assessment is expanded to include the ability to bear full or partial losses and risk tolerance. There is also a requirement that the client's explicitly request is required in order for a firm to proceed with a transaction that is subject to a warning that it is not appropriate. Enhanced disclosure obligations are also proposed (see section 8 below).

Knowledge (and competency) is everything

A lack of harmonisation across jurisdictions on the investment advisor knowledge and competency requirements has long been a bone of contention. To level the playing field the RIS proposes to codify into a new Annex V of MiFID the ESMA K&C guidelines as minimum standards. An understanding of sustainable investments has also been added to the list of requirements, as well as the introduction of acertification regime and minimum ongoing professional training.

Disclosures

Changes to the various MiFID disclosure requirements are proposed to encourage standardisation and increased transparency:

• Enhanced costs and charges disclosures for retail clients are proposed.
• ESMA is asked to prepare regulatory standards on a standardised form and content of costs and charges disclosures.
• A new concept of 'particularly risky products' is introduced. Firms must identify such products and include appropriate risk warnings in client communications, including marketing materials. ESMA is asked to prepare guidelines on how firms can identify these products, and also to prepare regulatory standards on a standardised form and content of those risk warnings.
• Suitability/appropriateness assessment warnings are added, to explain the purpose of these assessments and the consequences on the quality of those assessments if the client does not provide accurate and complete information. ESMA is asked to prepare regulatory standards on a standardised form and content of those warnings.
• Enhanced disclosures on marketing materials are also proposed (see section 9 below).

Marketing

Proposals to modernise MiFID marketing requirements to take account of digitalised marketing - including the use of social media, influencers and behavioural biases - include new definitions of 'marketing communications' and 'marketing practice'. There are enhanced disclosure requirements for marketing materials to make clear, in an ever-increasing digitalised world, essential information about the firm and the product, with further underlying legislation required to provide the details of these requirements. Firms will also be required to put in place a marketing policy which takes into account the target audience and which will sit under the responsibility of the firm's management body.

The EU strong arm of the law

In a move that is in line with the direction of travel we have been seeing over the last few years, there is an enhanced focus on national regulators and EU regulator MiFID information-gathering powers and interventionist powers. These are scattered throughout the RIS.

Financial literacy

Member States are required to promote measures to support retail clients' financial literacy. Importantly in order not to discourage product providers from producing financial education materials, these types of materials are explicitly excluded from the new definition of 'marketing communications' and 'marketing practice'.

Please contact one of the RIS team linked above or your usual Simmons contact if you have any questions.