Fund Forum Monaco 2010

Brussels to take action on selling practices

le 24/06/2010 L'AGEFI Hebdo

A proposal for a regulatory framework for packaged retail investment products, known as "PRIPs", is under consideration, to better protect consumers.

For several months European regulators have been closely following a major lawsuit in Charleroi, Southern Belgium. In 2008, some 4,000 Citibank customers were stupefied to discover that their savings - 130 million of euros - had been swallowed up in the collapse of… Lehman Brothers. According to the public prosecutor’s department last May: "There was a clear marketing policy intended to mislead customers about the risks of Lehman Brothers’ investment products." The Citibank case is obviously a specific case, but it clearly demonstrates, as far as the European Commission is concerned, the lack of regulatory framework governing the distribution of savings products. The financial industry’s lobbyists themselves recognise the problem and expect a clamp down. "Information and advice are not at the centre of current legislation", notes one of them. Eddy Wymeersch, the Chairman of the Committee of European Securities Regulators (CESR) - see profile page 11 -, lambasted UCITS last year, denouncing the lack of information available to investors, the rampant conflicts of interest and the lack of a counterbalance in the governance structures of such funds. Regulators have understood that in order to restore confidence in the financial system and, indirectly, in their capacity to regulate effectively, the supervision of systemic risks is not everything. It is also necessary to improve investor protection.

This concern, emphasised on several occasions by the European commissioner for internal market end services Michel Barnier, has resurfaced where it was not necessarily expected: alternative management.

Breaking new ground in the AIFM Directive

The AIFM (Alternative Investment Fund Managers) Directive which is in the process of being adopted, and concerns hedge funds, private equity funds and other unregulated funds, requires fund managers to act "honestly and fairly… in the best interests of the AIF…, investors and the integrity of the market". This is a first: no European text has previously been so explicit. It seems paradoxical that the European Commission has chosen alternative funds, which are more tailored to professional investors, to break new ground in this way, whereas UCITS compliant funds, which are distributed far more widely on the retail market, might have seemed a more obvious target. In reality, however, it is simply a matter of taking advantage of a window of opportunity. The winds of change are at work and the retail market’s turn will come, slowly but surely.

Brussels has been working for two years on the horizontal regulation of investment products, under the name of PRIPs (Packaged Retail Investment Products). "Our main motivation is to protect consumers…, notes an internal source. There is a problem of confidence, standards need to be raised." The project covers not only UCITS but also structured products and long-term life insurance savings products. Such products are currently regulated by sectors. The total PRIPs market is estimated at 9,000 billion euros. However, "the figure is probably overestimated", admits an internal source, as some UCITS are, for example, recorded twice: in their own right and in packaged banking and insurance products.

In April 2009, Brussels came up with a "communication" focused, on the one hand, on distribution rules and, on the other hand, on consumer information. But tidying up what the European Commission itself describes as a "patchwork" situation will take a lot more time. The consumer credit directive experience shows how perilous the geographical harmonisation of retails services can be. When sectoral harmonisation needs to be added to the equation, since insurance, asset management and banking activities are currently regulated by compartmentalised rules and regulations, the exercise becomes even more difficult. The European Commission’s internal market services hoped to put forward legislative proposals at the end of last year, then in June. The subject is now among Michel Barnier’s "priorities" for… 2011. Consumer protection is competing on the Commissioner’s agenda with a host of other equally pressing matters: regulation of derivative products, crisis management and the reform of supervisory systems. But the technical work is ongoing.

‘‘Well-informed decisions’’

First part of the project: the preparation of a key investor information document (KID). The last reform of the UCITS directive set a precedent with the key investor information (KII). The aim: "To enable investors to take well-informed decisions." The information must be "fair, clear, not misleading and presented in such a way that it enables investors… to shop around to find the products most suited to their needs", explains the European Commission. The "KID" should be "short, written in simple language" in a standardised format so as to facilitate comparisons. To overcome differences of structure and nature between products, the project is focusing on "cost, risk and performance", leaving room subsequently for "tailor-made" solutions by product classes. The European Commission has commissioned consumer research, using different information sheet models, in order to ascertain in a very concrete way how investors read, analyse and use this information. The results will be used to finalise the proposed legislation.

Selling practices are the second part of the project and this is probably the most difficult part of the PRIPs project. Pieces of legislation already exist - Markets in Financial Instruments (MiFID), Insurance Mediation (IMD), Life Insurance and the Prospectus directives - but they are not always consistent and have proved to be insufficient. The European Commission considers that: "Retail investors continue to purchase products without really understanding their characteristics." For the time being, it has decided to use, as the basis for new legislation, the MiFID which already contains numerous provisions governing conflicts of interest, motivation, product suitability and customer information. But these rules were designed for securities markets, not for retail distribution; they therefore need to be adapted. "The problem is that the MiFID does not cover insurance", emphasises a fund management professional. It will therefore also be necessary to make alterations to the IMD, if possible in a coordinated way.

Overall, the industry has welcomed the PRIPs project. It is difficult to be against the idea of improving the information provided to investors. "In principle the KID is a good idea but it is complicated. Some PRIPs are managed actively, while others are not. It is therefore tricky to compare performances. It would be better therefore to propose scenarios to customers so that they can understand the factors which might lead to changes in the return", explains an expert from the European Banking Federation. However, comparability is central in an approach which is intended to strengthen the investors’position vis-à-vis distributors. The fund industry is probably the most enthusiastic since it is also the most regulated in this area. It therefore suffers from the competition of products designed by banks… on which it is very dependent for the distribution of its own products.

Insurance misgivings

The insurance industry has the most misgivings: British and Dutch insurers have, for example, refused to support the position of the European Insurance and Reinsurance Federation (CEA) in favour of PRIPs. At a technical meeting organised in October 2009, the CEA proposed in addition to exclude "pure life insurance" contracts and "products which are not contractually linked to a fund or an index… and guarantee minimum interest and income throughout the life of the contract". In other words a significant part of the market.

The European Commission is currently considering the best strategy going forward. One solution would be to treat the KID separately in an ad hoc text, and to deal with selling practices in future revisions of the MiFID and IMD directives. In any event, however, the initial proposals are unlikely to be tabled before the beginning of next year.

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