Proposals for Better Management of Non-Financial Risks within the European Fund Management Industry

Proposals for Better Management of Non-Financial Risks within the European Fund Management Industry - December 2012

2. Key Topics on the European Regulatory Agenda

any advice, recommendation or offer to a particular client. Such firms are required by MiFID to collect such information as is necessary to understand the essential facts about a client and have “a reasonable basis” for believing that a transaction to be recommended, or entered into in the course of portfolio management: (i) meets the client’s investment objectives; (ii) does not entail investment risks that would not be financially bearable by the client; (iii) is such that the client has the necessary experience and knowledge to understand the risks involved. 33 For other investment services, the firm need only determine that the client has the necessary experience and knowledge to understand the risks involved in the field relevant to the specific type of product or service to be provided. In certain circumstances e.g. when a client chooses not to provide the information requested, the firm may still be allowed to provide limited services subject to explicit warnings. When providing investment services that only consist of execution and/or the reception and transmission of client orders, a firm does not need to make the above determination provided (i) these services relate to shares listed on a regulated market, money market instruments, bonds or other forms of securitised debt (excluding those embedding a derivative), UCITS and other non-complex financial instruments; (ii) the service is provided at the initiative of the client; (iii) the client has been clearly informed that in this context, the firm is not required to assess suitability; (iv) the firm complies with the conflicts of interest provisions of MiFID. The version of MiFID in force covers only a fraction of PRIPs market: distribution of insurance products

is regulated by the IMD and structured term deposits are outside the purview of MiFID.

On 20 October 2011, the Commission presented a proposed revision of the MiFID framework (draft Directive COM(2011) 656 and draft Regulation COM(2011) 652). It notably extends MiFID requirements to the advised and non-advised sale of structured deposits by credit institutions. The proposal strengthens investor-protection, notably by requiring firms to disclose whether investment advice is provided on an independent basis or whether it is based on a broad or on a more restricted analysis of the market; third-party inducements are prohibited when investment advice is provided on an independent basis and for all firms when providing portfolio management. 34 The proposed Directive also provides clarification on instruments that can be traded via execution-only services; are notably prohibited: shares in non-UCITS collective investment undertakings; shares, bonds and money market instruments embedding a derivative or a structure which makes it difficult for the client to understand the risk involved; and structured UCITS. 35 The issue raised here is that of the possibility of the structural complexity of the instrument hindering a non-professional investor’s ability to understand the risk of the instrument. Any product deemed complex would no longer be available to self-directed investors and such a classification could also negatively impact institutional demand. The proposed reform of the IMD aims to

33 - If the firm has classified the client as a “professional client” in relation to particular financial instruments as per MiFID, then it is entitled to assume that the client has the necessary experience and knowledge. 34 - At this stage, the European Parliament is likely to water down this proposal. 35 - Structured UCITS are “UCITS which provide investors, at certain predetermined dates, with algorithm-based payoffs that are linked to the performance, or to the realisation of price changes or other conditions, of financial assets, indices or reference portfolios or UCITS with similar features.” (Commission Regulation 583/2010.) Some forms of structured UCITS, e.g. capital- protected and guaranteed UCITS, are particularly attractive to retail investors.

Structured UCITS are subjected to specific

disclosure requirements in the context of the KIID to help investors understand their risk/return profiles.

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An EDHEC-Risk Institute Publication