The Retail Investment Package of the European Commission consists of an Omnibus amending Directive amending a set of different sector specific directives such as MiFID II and a Regulation amending the Packaged Retail and Insurance-based Investment Products Regulation (PRIIPs, Regulation (EU) No. 1286/2014). The European Commission’s aim is to increase the trust and retail participation in capital markets but also getting a better deal (“value for money”) for retail investors of investment products that are heavily dependent on advised services (see also the European Commission’s Q&A).

Proposed changes to MiFID II

The following summary highlights selected key aspects of the proposed amendments that are relevant to investment firms.

Disclosures and marketing communication: enhancing transparency

The proposal aims to improve the regulatory framework for disclosure in order to ensure transparency for retail investors and enable them to make informed decisions.

Marketing communication should be developed, designed and provided in a manner that is clear, fair and not misleading and should be balanced in their presentation of risks and benefits as well as appropriate for the target audience. The EU Commission will adopt a delegated act defining the essential product characteristics and the conditions to an appropriate design.

Furthermore, investment firms shall be responsible for the content and compliance of marketing communication, whether the communication is promoted directly or indirectly (e.g. through a financial influencer) by the investment firm. To ensure compliance and effective enforcement, investment firms shall be required to keep records on all marketing communication for a period of at least five years and provide management bodies with annual reports on the firm’s marketing strategy. Supervisory authorities shall have the possibility to suspend or prohibit inappropriate marketing communication.

Advice process: banning inducements and strengthening ‘best interest’ test

The Package does not provide for a full ban on inducements, as initially envisaged by the EU Commission to mitigate conflict of interests. Instead, the Package restricts the planned ban on inducements to certain individual cases and introduces a set of restrictions and safeguards in relation to inducements as well as transparency requirements.

Three years after the adoption of the Package, the EU Commission will review the newly introduced rules and assess the effect of inducements and, if necessary, propose legislative measures which could ultimately include a full ban.

Ban on inducements for non-advised sales

According to the proposed Package, investment firms shall not be allowed to accept inducements if they provide portfolio management or the reception and transmission of orders (RTO) or execution of orders to or on behalf of retail investors without having previously advised the retail investor on the product (execution only). This is the case, for example, if a retail investor makes an investment via the firm’s website and selects a product without a prior personal recommendation.

Exemptions with regard to placement and underwriting business and non-monetary benefits

The ban on inducements shall not apply where the investment firm receives inducements from an issuer for which it provides the placement or underwriting business. However, the exemption shall not apply to issuers of packaged retail and insurance-based investment products within the meaning of the PRIIPs Regulation. Also an exception is made for minor non-monetary benefits which do not exceed a total value greater than EUR 100 per year or which are of a scale and nature such that they cannot be considered to impair the investment firm's compliance with its duty to act in the best interests of the retail investors. Where inducements are permitted, the firm is required to disclose their receipt and further details such as their costs and impact on investment returns.

Improving the quality of investment advice

With regard to investment advice, the current MiFID II regime allows for inducements provided they enhance the quality of the investment advice and do not impair acting in the best interest of clients. To better mitigate conflict of interests, the Package proposes replacing the criteria by the following specific safeguards. Advisors shall act in the best interest of their client, by

• providing advise based on an assessment of an appropriate range of financial instruments;
• recommending the most cost-efficient financial instruments among financial instruments identified as suitable to the client and offering similar features;
• recommending among the range of financial instruments identified as suitable to the client, a product or products without additional features that are not necessary to the achievement of the client’s investment objectives and that give rise to extra costs.

Structured pricing process: amending product oversight and governance rules

The Package contains new rules for a pricing process to ensure that products offer a good value for money for retail investors. Investment firms which manufacture financial instruments for sale to clients must establish, maintain, operate and review a process for the approval of each financial instrument and significant adaptations of existing financial instruments before it is marketed or distributed to clients (the product approval process) and shall fulfil specific reporting requirements. An investment firm that offers or recommends financial instruments which it does not manufacture, must have in place adequate arrangements to obtain the information understand the characteristics and identified target market of each financial instrument. In addition, it must regularly review financial instruments it offers or recommends.

In this context, an investment firm which offers or recommends PRIIPs shall identify and quantify all distribution costs and charges of PRIIPs, as well as any other costs and charges that are not already considered by the manufacturer of the PRIIPs and assess whether those costs and charges are justified and proportionate, taking into account the characteristics, objectives, and if relevant, strategy and performance of the relevant PRIIP (pricing process).

In addition, the costs and charges shall be compared with benchmarks, published by the European Securities and Markets Authority (ESMA). Benchmarks are intended to make the pricing process more objective. For example, if product costs and charges deviate from the corresponding benchmark, this indicates that costs and charges are too high and that the product does not offer good value for money. In this case, distributors shall only be allowed to offer the product if additional testing and valuation prove otherwise.

The pricing process shall be complemented by reporting obligations requiring distributors to report the costs of distributing PRIIPs to the relevant national supervisory authority, including details of the costs of advice and inducements.

Adapting the suitability and appropriateness tests to the needs of retail investors

The Package provides for new obligations regarding the suitability and appropriateness assessments. The appropriateness test applies to retail clients in relation to execution services whereas the suitability test is required with regard to advised services. The proposals introduce an obligation for investment firms to explain the purpose of the assessments to clients in a clear and simple way and to obtain all relevant information from clients.

As regards the appropriateness test investment firms shall, as an additional element, obtain and assess the retail investor’s capacity to bear full or partial losses and its risk tolerance before executing an order on a complex investment product. In case of a negative appropriateness test, the firm shall only be allowed to carry out the transaction at the client’s explicit request.

When assessing suitability, advisors are also required to assess whether a product is suitable for a client in view of the client’s existing portfolio composition and the need for portfolio diversification.

The EU Commission also proposes a form of simplified advice for independent advisors in order to encourage independent advice at a reasonable cost. Independent advisors shall not be obliged to obtain prior information on the retail client’s knowledge and experience or on their existing portfolio composition, if the advice is limited to financial instruments that are diversified, non-complex and cost-efficient. In that case, they shall be allowed to perform a suitability assessment on the basis of more limited information.

Ensuring high professional standards for investment advisors

The Package introduces new requirements to strengthen the knowledge and competence of investment advisors and wealth managers, including maintaining this through annual ongoing professional training, which shall be demonstrated by obtaining a certificate.

Client classification: easing the qualification as professional investor

In order to ensure a more appropriate classification of clients and to reduce the administrative burden, the criteria for determining which clients can be treated as professional clients upon request shall be changed. Adjustments include the reduction of the minimum wealth criterion from EUR 500,000 to EUR 250,000 and the addition of a possible fourth criterion relating to relevant education or training. The new rules would allow a wider range of investors to seek an exemption from the retail investor protection framework.

Strengthening cross-border supervisory cooperation and enforcement

The proposal aims to strengthen cooperation and enforcement by supervisory authorities, in particular on a cross-border level. Therefore, the package proposes rules that focus on improving and accelerating cooperation between home and host state competent authorities. For example, where there is a justified concern about a negative impact on investors due to investment firms providing cross-border services, ESMA may, on its own initiative or at the request of national supervisory authorities, establish and coordinate a cooperation platform to enhance the exchange of information and cooperation between competent supervisory authorities.

Promoting financial literacy

Member states shall be required to promote measures that support the education of retail investors on financial investments so that investors develop necessary knowledge, confidence and awareness for investments that contribute to their financial needs.

Next steps

The proposed Omnibus Directive provides for significant adjustments to the existing regulatory requirements and some provisions could have a far-reaching effect on the business models and revenues of EU investment firms.

The draft will now follow the EU legislative procedure. After the entry into force of the legislative package, the changes must be implemented by the Member States within 12 months and be applicable after 18 months. Given the European Parliament elections next year, the far-reaching changes and ongoing discussions, it is rather unlikely that the changes proposed in the Retail Investment Package will enter into force before 2025.

As the draft law is still being consulted, there is no urgent need for action at present – but developments should be closely monitored, the impacts analysed and taken up at an early stage through appropriate organisational measures.