In 2018, fund distributors will have to comply with Priips and MiFID II on top of existing Ucits rules. Nicholas Pratt looks for any common themes.
Faced with multiple regulations, market participants are looking for areas of commonality. Fund distributors and manufacturers will have to comply with at least two new tough measures next year: MiFID II (the revised Markets in Financial Instruments Directive) and the reporting rules for Priips, the Packaged Retail and Insurance-based Investment Products Directive.
Along with Ucits, these all share the same overall intention: to restore investor trust through greater transparency and information.
There may be some philosophical differences between Ucits, which is more about product governance and protection of the Ucits brand, and MiFID II and Priips, which are more concerned with investor protection, but all three will have consequences for fund distribution.
Yet there are some areas where these rules could create crossover for fund distributors, specifically around MiFID II and what it interprets to be a ‘complex product’.
Any such complex fund will require an extra layer of financial advice, and this could hinder distribution licences granted under Ucits, says Ahsan Mallick, general counsel at SEI UK and executive sponsor of Codify, an incubator for regulatory technology (regtech) products.
Not all Ucits management companies are MiFID-registered firms but the requirement will still impact them indirectly via their distribution chain.
A further difficulty is the lack of clarity over what constitutes a ‘complex’ product. There are various safe harbours such as an ETF that invests in vanilla equities, but there is still a large grey area around any structured Ucits products or funds even with a hint of alternatives about them.
Of equal concern to fund distributors and manufacturers will be the various points of crossover and the temptation to indulge in regulatory arbitrage.
“It is a delicate point,” says Mallick. “There are common themes of disclosure with Priips and MiFID, but Priips will have a narrower scope and be more prescriptive over details like risk calculations and the language for disclosure. In contrast, MiFID will have a much wider scope.”
AIM FOR THE HIGHEST
For distribution strategies, the wide and geopolitical scope of MiFID should be the main driver. But when it comes to implementation of disclosure texts for retail products, the detail of Priips could take precedence, says Mallick. “The devil will be in the detail and there will inevitably be some crossover but if in doubt, firms should aim for the one with the highest standards.”
The Priips reporting document is supposed to replace the Ucits Key Investor Information Document (KIID) in 2019, but one issue is how long a firm can carry on using the KIID, says Jean-Pierre Gomez, head of regulatory and public affairs, Luxembourg, at Societe Generale Securities Services (SGSS).
“The European Banking Federation recently issued a paper on Priips which was accepted by the European Commission, so we expect it to be confirmed soon,” he adds. In the meantime there are issues around inconsistency while both documents are in circulation, says Gomez. Firstly, the KIID does not include anything about future performance or expectations and may not meet the ‘target market’ rules of Priips. Secondly, there are legal and contractual differences. “Every time a manufacturer works with a distributor with a Priip, there is a contract but on the other hand, in the secondary market when intermediaries are selling funds, there is no contract. We need to ensure we have legal certainty for retail investors and that investors know what to do if they have both documents,” says Gomez.
Service providers, from depositary banks to software vendors and market data providers, all anticipate that they will play a greater role in the compliance effort and as intermediaries in the relationship between distributors and manufacturers.
Gomez says: “The industry used to have a basic view of regulation that was very compliance-focused but that is not enough any more. It is no longer just a KYC [know-your-customer] approach but about knowing your process. You have to look at the commercial impact, the technology impact, the risk impact and the operational impact. After looking at all of these impacts, some firms may decide that they cannot manage all of this on their own, or even that it doesn’t make sense to stay in certain markets.”
AHEAD OF THE BANKS
For once, though, asset managers may find themselves ahead of their investment bank counterparts when it comes to compliance with some aspects of MiFID II, says Phil Lynch, head of markets, products and strategy at Six Financial Information.
Ucits rules and their KIIDs mean fund managers have already set up the infrastructure for fund distribution, unlike for other asset classes. But the infrastructure has been built for the investment funds business whereas Priips and MiFID II rules span asset classes. Furthermore, the KIID relates to subscription and other documents, whereas Priips and MiFID II deal with much more asset-related data.
“That is the biggest issue, the added complexity, as well as the need for the exchange of data,” says Lynch. “Funds may change less often than other asset classes especially compared to structured products, which may change hourly. Also, the calculation requirements of KIIDs are more static compared to Priips and MIFID II requirements.”
Fund distributors and manufacturers will therefore need to check that their infrastructure is able to support this complexity and keep in mind that Ucits will fall under Priip regulations by the end of 2019, says Lynch.
“There will be a need for a more dynamic relationship between manufacturers and distributors and a more dynamic operational set-up – an automated interface that ensures the right documents in the right language for the right jurisdictions are provided whenever a portfolio needs to be updated. It will also ensure that other data is shared and updated such as the itemised cost breakdown information, which should be in line with what is presented in the documents.”
In addition to the complexity, there are also complications around various definitions, rules and respective responsibilities for both manufacturers and distributors, says Lynch. For example, fund managers that solely carry out collective portfolio management are not subject to MiFID II rules unless they also provide MiFID II investment services.
This will be critical in defining who is responsible for providing regulatory data and may result in individual agreements between firms. If a manufacturer does not provide the required information, the distributor has the choice to step in and define the target market itself, or to adjust the product universe, says Lynch.
When faced with multiple regulations addressing the same general theme, market participants will always look for common ground that will enable them to avoid a duplication of effort. One example is using the same channel established between distributors and manufacturers for the MiFID II investor protection and target market rules, requirements that do come into Ucits and Priips but at a much higher and less detailed level.
“The industry is currently defining best practice and how to define client needs, one aspect of the target market definition. If this is defined too narrowly by the manufacturer you could easily end up outside the target market when selling a product to a customer, which will then become the distributor’s problem,” says Lynch.
“So there will have to be a balance, to provide enough information to distributors to comply and address investor protection, but not too much that they become swamped. It is about defining a set of rules at the outset of the relationship.”
Education will also be a much more important part of the process, says Gomez at SGSS. “The ‘simplified prospectus’ was introduced to bring more clarity to the process but they ended up being longer than the original documents. They were then replaced by the KIID, which will now be replaced by the Priips KID [Key Information Document].
“But the investor still needs to know what all the jargon means – it is not just about information. And it is the distributor that will have to ensure that the investor understands.”
With so much on their plate, the level of preparedness among both manufacturers and distributors is definitely an area of concern, says Lynch. Priips was originally meant to be live in January 2017 but companies only started to wake up in the third quarter of 2016 because of a lack of clarity and the wait for finalised details via the regulatory technical standards. It was then put back for a year, but instead of jumping on it and using that extra time, firms have put it back to the second half of 2017.
“At the same time, there is another regulation to deal with [MiFID II] and if you are building or installing a new platform or even just enhancing the current one, it will have to be tested and that will take time,” says Lynch. “Most importantly, both parties, manufacturer and distributor, need to be connected and ready.”
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