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PRIPs: Proposed Regulation on pre-sale disclosures for Packaged Retail Investment Products – interaction with RDR and MiFID II The European Commission has now published its final proposal for a Regulation on mandatory pre-sale disclosures for Packaged Retail Investment Products (PRIPs). The Regulation aims to close gaps and inconsistencies in current rules across Europe by introducing uniform rules on product disclosures. The Commission last consulted on these reforms in January 2010, so the draft Regulation has been a long time coming.

This briefing summarises the new PRIPs Regulation and considers the interplay with disclosures required by the RDR and revised MiFID. Insurance intermediaries may also be interested in our briefing on proposed revisions to the Insurance Mediation Directive.

This Regulation is likely to considerably increase the costs and resource already being expended in implementing related rules under the FSA's RDR and the Commission's review of MiFID (MiFID II). Estimated industry compliance costs are €171 million initially and €14 million per year thereafter.

Key points

• Standardised form of disclosures will be required for a broad range of retail investment products

• A lack of clarity on which products come within scope may cause difficulties for firms

• Product providers, or those who substantively change the risk or costs structure of the product, will be responsible for producing the Key Information Document (KID) – production can be delegated, but responsibility cannot be assigned

• PRIPs KID is based on UCITS KIID and so will already be familiar to some firms

• Regulation does not conflict with RDR, but RDR and MiFID II required disclosures may do so

Timeline

End 2014 Regulation to come into application (direct implementation)

2018 Review of Regulation, resulting in possible widening of scope

2019 End of transitional period for UCITS disclosures under UCITS IV Key Investor Information Document (KIID)

Financial regulation briefing

31 July 2012

Scope 2

Product provider responsibility 3

Key disclosures 3

Interaction with RDR and MiFID II 4

Comparison of PRIPs, RDR and MiFID II disclosures 5

Contacts 7

Related links

Herbert Smith website

Herbert Smith FSR notes

July 2012 Financial regulation briefing

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Scope

The Regulation will apply to investment products sold to retail investors, irrespective of whether they are sold on an execution-only or advisory basis.

Investment products are defined widely as "an investment where regardless of the legal form of the investment the amount repayable to the investor is exposed to fluctuations in reference values or in the performance of one or more assets which are not directly purchased by the investor". This is intended to capture all:

• Products with capital guarantees, including where a proportion of the return is guaranteed

• Investment funds, whether closed-ended or open-ended

• UCITS (firms can continue to use the UCITS IV Directive KIID for five years from the date the PRIPs Regulation comes into force – note that the UCITS KIID and the PRIPs KID are not the identical although both share common information)

• Structured products (excluding structured deposits, see below), in whatever form (eg, packaged as insurance policies, funds, securities or banking products)Insurance products whose surrender values are determined indirectly by returns on the insurance company's own investments, or the profitability of the firm

• Derivative instruments

• Private pensions

Products failing outside of scope include:

• Products where the precise rate of return is set in advance for the entire product life

• Plain shares and bonds (insofar as they do not contain a mechanism other than a direct holding of the relevant assets)

• Deposits which are not "structured" (these will be regulated under MiFID II)

• Pure protection insurance and non-life insurance products, which provide no surrender value that is exposed to fluctuations in the performance of one or more underlying assets or reference values

• Occupational pension schemes and pension products where employer financial contributions are required by national law and where the employee has no choice as to the pension product provider

The broad definition may help to ensure flexibility in accommodating financial innovation. However its lack of clarity may well cause difficulties for firms in determining the application of the rules. It is therefore important that the scope of the definition is clarified. The Commission had originally proposed to supplement the definition with an "indicative list" of products. This provoked concerns that such list could be used as a way to extend the reach of the definition to bring products within scope, without proper consultation. The Regulation does not take this proposal forward. Although this removes such concern, an indicative list would have been of assistance to firms.

The FSA intended its definition of "retail investment products", as introduced by the RDR, to mirror the definition in the PRIPs Regulation. Indeed an alignment would make sense. The PRIPs definition did not originally match the RDR's definition. The PRIPS version did not include personal pensions (which the RDR definition covers), but did include structured deposits (which the RDR does not). The PRIPs definition has now moved closer towards the FSA definition, as these two inconsistencies have been ironed out.

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Product provider responsibility for producing disclosure document – but distributor responsible for providing it

The Commission had originally consulted on two alternative approaches to the allocation of regulatory responsibility for producing the disclosure document:

(1) placing sole responsibility on the product manufacturer; or

(2) the more flexible option of not explicitly assigning responsibility, but with the product manufacturer and distributor agreeing responsibility contractually.

The Commission is not taking forward either option. Instead the following will be expressly responsible for producing the KID:

(1) product providers (even where preparation of the KID is delegated to distributors, eg, where it is "impractical" for the provider to produce the document); or

(2) those who "substantively change" the risk or costs structure of the product. This is intended to cover the situation where product providers do not exercise control over the final product. Whilst this concession is welcome, further clarity is required as to exactly when responsibility will shift in this situation. It would be sensible for product providers and distributors to seek to contractually agree the position up front.

Whilst this outcome provides some flexibility, it does not go as far as recognising that there may be circumstances where it would be more appropriate for the distributor to produce the KIID - for example, where a product has not been manufactured with retail investors in mind, but may ultimately be sold to retail investors by distributors.

The entity selling the product will be obliged to provide (rather than merely to offer) the document to the investor "in good time" before the sale. The Regulation provides some flexibility, in that the KID may be provided after the transaction where sales are conducted through distance communications.

The burden of proof will be on those with responsibility for producing the KID to prove that it KID was produced in compliance with the Regulation. It will still however be incumbent on the investor to prove loss.

Key required disclosures

The KID will be based on the principles in the UCITS KIID and so will already be familiar to some firms. The Regulation stipulates the requirements as to the form and language of the disclosures: eg, it must be a short standalone document, concisely written, understandable by the "average" or "typical" investor and in a format to enable comparisons to be drawn between different products.

The key disclosures include:

• Product's nature and main features

• Risk and reward profile

• Performance scenarios

• Liquidity profile

• Direct and indirect product costs

• Past performance

• Possible future outcomes for private pensions

It is helpful that technical standards will be published on methodologies for calculating summary disclosures of risks and costs. Further delegated / implementing acts will specify the: presentation, format, content and timing of the KID, as well as its revision and review, although the timing of these is not known. The Commission will have to strike the right balance between providing adequate information to consumers on the one hand, and on the other hand, not overloading the KID and over-regulating.

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The Regulation expressly states that these delegated acts should take into account differences in products and investor capabilities. This proportionality will be important in avoiding over-regulation.

One piece of the pie: interaction with RDR and MiFID II

As the deadline for compliance with the UK's RDR rules draws closer, its interplay with the PRIPs initiative and the Commission's review of MiFID has perhaps not attracted as much attention as it deserves. Given the significant time and resource required for firms to implement the RDR, this is understandable. However, the publication of this Regulation is a further reminder that the RDR is only one piece of the pie. As all three initiatives contain disclosure requirements (see table below for summary), ideally, the strands would have dovetailed. But in many respects, notably in relation to MiFID and RDR, they may not. This may well cause implementation challenges for firms in reconciling the different rules. Whilst the revised MiFID text has not yet been finalised, firms still need to consider the potential impacts.

The PRIPs Regulation will sit alongside the RDR rules: the disclosures required by both do not overlap (see diagram below). However, the disclosures required by the RDR and the new MiFID may not sit so comfortably. For example:

• Where structured deposits are sold, MiFID II disclosure requirements are set to apply (as structured deposits are not caught by the RDR (or PRIPs)).

• Where personal pensions are sold, the RDR (and PRIPs) requirements will apply (as these are not encompassed by MiFID II).

• A further complication is that the MiFID II disclosures are likely to apply where any "financial instruments" are sold to any type of clients (even though logic would suggest that the requirements should be diluted for professional clients and eligible counterparties). The RDR (and PRIPs) disclosures however are only required where investment products are sold to retail clients.

• Where products within scope of both the RDR and MiFID II (eg, structured products) are sold to retail clients, the FSA could apply the RDR requirements. This is because the Commission's new draft MiFID Directive does not (as currently drafted) prohibit Member States from imposing stricter rules.

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Interaction of PRIPS with RDR and MiFID II

Comparison of key disclosure requirements

PRIPs Regulation RDR MiFID II

Key product disclosures

• Nature and main features

• Risk and rewards

• Performance scenarios

• Liquidity profile

• Past performance

• Possible future outcomes for private pensions

• None required

Note that COBS already requires firms (subject to certain exceptions) to prepare key features documents / illustrations for certain "packaged products" (ie, life policies, units in a regulated collective investment scheme, interests in investment trust savings schemes, stakeholder pension schemes and personal pension schemes).

• None currently required

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PRIPs Regulation RDR MiFID II

Where a product falls within the wider definition of "retail investment products", but is not a packaged product, product disclosures will still be subject to the overarching ‘fair, clear and not misleading’ requirement.

Costs disclosures

• Direct and indirect product costs

• Adviser charging structures

• Total adviser charges payable, and amount / frequency of any on-going payments, including:

­ What service the charge relates to

­ When charge due

­ If charge varies materially from that indicated in charging structure

­ Charge may increase as fund grows

• None currently required

Note that press reports indicate that the European Parliament's Committee on Economic and Monetary Affairs has proposed that advisers should disclose commissions received by third parties (as opposed to a ban on the receipt of commissions).

Nature of advice disclosures

• None required

• Whether advice is independent or restricted

• If independent, but does not include all retail investment products: must explain that market, including types of retail investment products which constitute that market

• If restricted: must explain (in writing) whether advice is limited to retail investment products from a single company, a single group of companies or a limited number of companies – additional oral disclosure that advice is restricted required

• If both, a firm must clearly explain the different nature of the advice

• Whether advice is:

­ Independent

­ Based on a broad or restricted analysis of the market

­ Includes an on-going assessment of suitability

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Contacts

Martyn Hopper (partner) +44 20 7466 2139 [email protected]

Clive Cunningham (partner) +44 20 7466 2278 [email protected]

Karen Anderson (partner) +44 20 7466 2404 [email protected]

Christine Astaniou (professional support lawyer) +44 20 7466 2894 [email protected]

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© Herbert Smith LLP 2012

The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on the information provided herein.