By Jean-Florent Richard (pictured) & Pilar de Terry – Next year sees the introduction of two major pieces of regulation both of which will have implications for how asset managers distribute their investment funds across Europe. Simply put, MiFID II will apply to investment firms manufacturing and/or distributing financial instruments while the PRIIPS regulation applies to all unit-linked funds, structured products and retail investment products.
A common aim of these regulations is to increase transparency and governance of mainstream European fund structures such as UCITS and AIFs, with the aim of bolstering investor protection. Overlap between the two regulations will mean asset managers will not necessarily be required to duplicate the gathering of data, while similar disclosure requirements will also reduce some duplication. Under the PRIIPs Regulation, a Key Information Document will need to be produced (building upon the pre-existing UCITS Key Investor Information Document). This document will have to be provided to European retail investors either directly or through financial intermediaries.
Both regulations are complex and nuanced. How asset managers cope with the product governance and distribution challenge will, in part, depend on the quality of the service providers they have – especially the fund administrator, as they may potentially hold much of the data needed to meet the various reporting and disclosure requirements.
Amongst many others, one specific point that is attracting a lot of attention in relation to MiFID II is that product manufacturers/asset managers (and, by default, distributors) are required to define 'target markets' for each of their funds. This is a new requirement.
The target market must ensure that the product ends up with the type of customers for whose needs, characteristics and objectives it has been designed.
Based on consultations with our clients, small and mid-sized asset managers often may not have the internal resources to properly identify the target markets of their various products. Some have their doubts about how to do this at present and are worried they may not be able to fulfil these new requirements in time.
Each EU Member State may have its own definition of target market, which adds to the complexity.
This is a challenge for both the product manufacturer/asset manager and the distributor. Both will need to determine the appropriate strategy for defining target markets. It must then be produced and shared across the distribution chain.
Both parties have to put in place new communication, governance and co-operation arrangements to make sure the relevant information is shared. This is particularly the case if a fund is in breach of the target market rules and is therefore mis‑sold.
There will be a reinforcement of the link between the product manufacturer/asset manager and the distributor, given the latter will have to take responsibility to ensure the general consistency of the products that are going to be offered and the related services that will be provided with the needs, characteristics and objectives of target clients.
Even within the broader regulatory challenges currently faced by asset managers, PRIIPS and MiFID II stand out as particularly complex. Project managers heading the efforts to successfully comply with these two legal frameworks are well aware that the texts have given rise to divergent interpretations among practitioners. The European Securities and Markets Authority (ESMA) has gone to some length to address these complexities, particularly through its questions and answers (Q&A) of June and August of this year, which provide guidance on the interdependencies between MiFID II and PRIIPS. Nevertheless, this is an extremely complex regulatory framework and its application in practice is still not crystal clear.
Based on ESMA's Q&A, MiFID II requirements, in terms of cost and risk disclosure to investors, are now aligned with PRIIPS on methodology and are in the regulatory schedule. Asset managers will be able to streamline the document production processes across their fund range targeting retail and institutional investors in the European Economic Area.
The race to readiness
In June, the market started working on a readiness effort for a go-live of their PRIIPS project in January 2018.
This preparation period, in reality, is reduced to three months, in cases where investment funds are the underlying of multi-options PRIIPs. Already insurers under the obligation to produce their own PRIIPS KID have started requesting data from their service providers in order to test their platforms.
Asset managers now have a larger scope of funds impacted by transparency regulations and need to ensure reporting updates when there is a significant variation in the costs of the product. They have to efficiently produce and check data on a regular basis, thereby managing larger data volumes will now be, without question, part of the process.
Data monitoring will also mean ensuring that the quantitative indicators to communicate to the final investor represent a true and fair image of the investment profile of the fund. In particular asset managers must publish a new KID when:
Managing the impact of regulatory differences, despite the synergies
Differences in UCITS KIID and PRIIPS KID regulations are evident in the higher level of complexity of the latter. Particularly as regards the calculation of costs and charges, PRIIPS introduces additional requirements on transaction costs. Moreover, in the area of performance and risk indicators, PRIIPS does away with the past performance methodology and requires product developers to calculate future performance in different market scenarios.
We could also say that risk and performance calculations appear closer to reality in PRIIPS. Still, the risk model could be at stake in cases of a market crisis. Projections will be impacted when a short period of bad market returns impacts the calculation of the risk/performance scenarios.
Also worth mentioning is the disparity of risk indicators, from a 1 to 7 level in PRIIPS versus UCITS KIID scale for a given volatility. Asset managers may end with different risk measures for similar fund types depending on the regulation referenced for the KIID/KID production and with the challenge of having to reclassify the full range of funds under the PRIIPS regulation.
What will the 2018-2019 period look like? By 31st December next year, the European Commission will review the regulation. All stakeholders of this regulation hope that any revisions will result in the simplification of the current requirements. Until then, fund managers in their role of product manufacturers need to comply with foreseen regulations as well as with the commercial engagements they undertake with their institutional clients in the insurance industry.
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