Proposals for an EU Retail Investment Strategy

The European Commission has published proposals for an EU “Retail Investment Strategy” as part of its Capital Markets Union initiative, following its 2021 consultation. The proposals aim to modernise and streamline the investment framework in order to increase trust, transparency and investor participation. Notably, ESMA and EIOPA will have important roles to play, with increased powers and resources.

The Commission's initial considerations were debated and discussed by the industry, including the introduction of a "semi-professional" client category and a potential ban on inducements. On the former, the Commission proposes only some adjustments to the definition of professional client. On the latter, the Commission now proposes only a partial ban. However, various other amendments are proposed to enhance investor protection, including a form of "value for money" assessment. Given the provisions would apply only 18 months after the amendments enter into force, and the scale of the proposed changes, the implementation timeline is likely to be challenging. 

This article summarises the proposals and their practical implications, and given the strong parallels with the core elements of the Consumer Duty, compares and contrasts them with the requirements in the UK. 

A wide range of firms will be impacted by the proposals, including fund, wealth and asset managers, banks providing retail investment services, insurers offering investment products, platforms, investment advisers and retail brokers. 

The proposals mainly apply to MiFID and insurance firms (the latter via amendments to the Insurance Distribution Directive (IDD)), but aspects of the undue costs and pricing proposals will also apply to UCITS and AIF managers:

The Commission's package sets out new requirements and enhancements to the investor protection framework in a wide range of areas. The most important aspects are around:

• Value for money (VFM) and product governance: The proposals take account of ESMA's recent opinion on considering "undue" costs in UCITS and AIFs, including assessing the eligibility of costs, developing a structured pricing process that takes into account various factors, and reimbursing investors on a timely basis, where required. MiFID and IDD firms will also need to implement a structured pricing process. Notably, ESMA and EIOPA would be given a mandate to regularly update cost and performance benchmarks, against which manufacturers would need to compare their products before offering them to the market. New reporting obligations on costs and charges would inform these publicly available benchmarks, although the goal is to base the reporting requirements on existing data where possible. In addition to the VFM proposals, aspects of the product governance requirements are amended (e.g. on the product approval process).
  
  
• Simplifying disclosures: Firms would need to display risk warnings for “particularly risky” products (to be defined by ESMA and EIOPA); disclosures would be provided in electronic format by default (aligning IDD requirements with MiFID); a new annual statement would be provided by firms to clients; there would be a standardised presentation of information on costs, associated charges and third-party payments; and a standard disclosure document would be introduced for life insurance products. 
  
  
• Stricter rules on marketing communications: New obligations are being consulted on, such as the requirement for management bodies to define, approve and oversee a policy on marketing communications, a clearer division of responsibility between manufacturers and distributors, and enhanced record keeping requirements.
  
  
• Client categorisation: Changes to MiFID, for clients requesting to be treated as “professional”, would include reducing the minimum wealth criterion from EUR 500k to EUR 250k, and adding a new criterion around professional experience or education. 
  
  
• Enhanced standards for investment advisers/wealth managers: New requirements to strengthen the knowledge and competence of investment advisers and wealth managers, including maintaining this through annual continuous professional training and development (to be evidenced by obtaining a certificate). 
  
  
• Adapting the advice suitability and appropriateness test requirements: New obligations (such as explaining the purpose of the assessment in a clear and simple way) and expansion of the appropriateness test to encompass the client's capacity to bear full or partial losses and risk tolerance. Notably, a streamlined suitability assessment is envisaged where firms could provide advice on a limited range of financial instruments that are diversified, non-complex and cost-efficient.
  
  
• Tackling bias in the advice process: A ban on inducements paid from manufacturers to distributors for execution-only sales (i.e. no ban on advised sales — but this position would be reviewed three years after the proposals come into force), rules to "further substantiate" the need for firms to act in their clients' best interests, and new tests for advisers to consider when recommending products.
  
  
• Strengthening supervisory enforcement: New powers would be given to National Competent Authorities to act where investors may be harmed (for example, to take prompt action on misleading market practices and carry out "mystery shopping" exercises), and to introduce reporting for firms on cross-border services.
  
  
• Promoting financial literacy: Member states would be required to promote measures supporting the education of retail clients.
  
  
• Amendments to the PRIIPs Regulation: In addition to the above changes that will be brought about through a new directive, the Commission has proposed amendments to the PRIIPs Regulation. They include changes to the PRIIPs Key Information Document (KID) to introduce a new section ("product at a glance"), removing elements that are not considered effective (e.g. the "comprehension alert"), and the addition of a new sustainability section that builds on existing ESG disclosures (titled "how environmentally friendly is this product?"). There are also measures to modernise and simplify the KID and a preference for electronic format.

To some extent, the Commission's proposals mirror long-standing requirements in the UK (including those via the Consumer Duty). Although some of the themes are the same, the details look quite different. In practice, this represents regulatory divergence that firms will need to manage. 

The key overlapping themes are:

• Value for money: Since 2019, the UK has required an "assessment of value" to be performed for UK-authorised funds that considers seven minimum criteria. Similarly, since 2021 the UK has had rules on pricing practices for some GI products. Further, Consumer Duty requires a fair value assessment for all retail products that considers a product's costs and benefits. UK implementation has been a supervisory priority for the FCA and has resulted in several multi-firm reviews and findings (e.g. see here).The EU's proposals for a structured pricing process and benchmarks are more formalistic, and for funds, there is a greater focus on the cost element of the framework. It is likely the EU expectations will evolve over time, and as in the UK, supervisors will scrutinise firms' application of revised policies and procedures. 
  
  
• Ban on inducements: The UK (and the Netherlands) have long had a full ban on commissions paid from manufacturers to distributors. In the UK this has been in place for over ten years and has led to the FCA identifying a material increase in the quality of advice suitability. The proposed EU ban would apply only to execution-only services but with a review after three years. Operating a partial ban will introduce operational complexity for firms.
  
  
• Proposals for limited advice: The UK has recently proposed a "core investment advice" regime, which aims to provide retail investors with greater access to simplified advice. However, the proposals have not been well received by industry — firms found it challenging to envisage solutions that worked both compliantly and commercially. The FCA and HMT are also planning a more strategic review of the boundary between advice and guidance. The EU's proposals are not dissimilar to the UK proposal on core investment advice in terms of streamlining the suitability assessment when it comes to investing in certain financial instruments. It will therefore be interesting to see if EU firms view the Commission's proposals as more workable.
  
  
• Acting in the customer's best interests: The Consumer Duty will introduce a new FCA principle that firms "must act to deliver good outcomes for retail customers". The EU's proposals would introduce various enhancements when it comes to considering clients' best interests. For advice, certain tests would be introduced (for example, recommending the most cost-effective product). However, focusing too narrowly on specifics such as cost-efficiency may in some cases result in poor outcomes (i.e. other factors such as product features, benefits and flexibility are also important considerations). The UK's approach is more focussed on outcomes and the FCA does not have equally prescriptive requirements in this context. 
  
  
• Customer understanding and disclosures: In the UK, the government and the FCA have asked for input on amending the UK PRIIPs regime and creating a "future disclosure framework." Additionally, the Consumer Duty introduces a consumer understanding outcome, requiring firms to equip consumers with the right information at the right time to put them in a position to meet their needs and financial objectives. The EU proposals will modernise PRIIPs disclosures, standardise the disclosure of costs, and promote the use of electronic format for communications. However, mandated disclosure can often adversely impact customer understanding due to the absence of flexibility to tailor for specific circumstances and/or segments of customers. This is where the UK and the EU appear to be moving in different directions, with the UK moving more towards an outcomes-based solution.

The Commission's proposals will now be debated, negotiated and agreed between the European Parliament and the Council, which could result in various amendments to the proposals. The Commission is assuming the legislation will enter into force in 2025. In the meantime, some may question whether the proposals go far enough to improve retail customer outcomes, but others may argue that some developments are better than none.

Whatever the final outcome of the legislative process, there will be a significant amount of implementation work for firms. UK groups with EU entities will need to implement the requirements relatively soon after the Consumer Duty, and EU firms operating in or marketing into the UK (e.g. potentially under the future Overseas Funds Regime) may also need to implement aspects of both sets of requirements. 

Many of the implementation challenges with the EU requirements will look similar to those experienced with Consumer Duty — for example scoping the changes needed on a legal entity basis and performing gap analysis, establishing value for money frameworks, evidencing good outcomes, meeting additional MI and data requirements, and reviewing governance structures. 

Careful thought will need to be given in approaching this from a regulatory change perspective, considering lessons learned, and ensuring that the requirements are fully embedded at all levels in the business to ensure good consumer outcomes. To read more about Consumer Duty implementation in the UK and investor protection initiatives around the world, please see below.