Two major pieces of investor protection legislation are causing headaches across the EU – with at least one global investment bank still looking at ways to sidestep the requirements and continue business as usual.
The Markets in Financial Instruments Directive (Mifid) II, and the Packaged Retail and Insurance-based Investment Products (Priips) regulation are designed to complement each other. But with the two becoming effective just days apart – causing sleepless nights throughout December – cracks in application and understanding of the rules are emerging.
According to sources, in the absence of further guidance and “because some of it just makes no sense”, Priips manufacturers have largely been taking a best efforts approach. “Firms know that some of what they’re producing for Priips isn’t accurate, but what else can they do?” said a London-based lawyer. “The regulator can’t realistically be too heavy-handed.”
Mifid II hopes to better protect investors by making manufacturers more accountable for ensuring the end-user of their products is the right one which, until January 3, was a responsibility that lay solely with the distributor. Meanwhile Priips is centred on the production of a three-page key information document (KID); the aim of which is to make investment products more accessible and easily comparable for retail clients.
Lawyers, bankers, regulatory strategists and product manufacturers have spoken exclusively to Practice Insight to air their grievances with the two sets of rules, just three weeks since their formal implementation.
KEY TAKEAWAYS
Banks have spoken exclusively and frankly to Practice Insight on the teething problems arising from two new investor protection regulations, Priips and Mifid II's product governance regime;
At least one US investment bank's European arm is attempting to implement the rules as lightly as possible and continue with business as usual;
Discrepancies in the suitability of certain products between different banks is causing problems in the Nordics;
Product manufacturers are also incredibly concerned about the point of liability when instruments are sold on in the secondary market, with little clarity from the regulators;
The scope of Priips has also caught some firms by surprise, with new instruments being considered packaged every day in the lead-up to implementation at the beginning of this month.
Product governance: the entire framework
IFLR reported last August that both Priips and Mifid II have forced an overhaul of existing business models by requiring better communication lines between the manufacturing and distributing arms of banks. But according to the regulatory change manager of a US investment bank based in London, his firm has “force-fit the [product governance] rules into existing structures rather than tried to embrace the fundamental change the regulators are hoping to achieve”.
He thinks that implementation of Mifid’s product governance rules will be both varied and as light-touch as possible among many firms, adding: “there’s this conflict because some of these smaller players that manufacture products now have more say over where they end up, but the distributors don’t want to give up that power…most of the people I’ve spoken to want to just carry on doing things as they always have”.
The regulatory change manager added that his firm spent some time lobbying regulators as it did not like the three categories of investors determined by Mifid II. “They essentially thought they could persuade the regulator to introduce a fourth category, which would catch practically all their clients and get them across the line,” he added.
Mifid II: target market determinations
A source on the fixed income desk of a major Nordic bank said that inconsistencies in target markets have already arisen between firms, citing collateralised mortgage bonds in particular.
He explained that while these have historically been available to Swedish non-professional investors – and are still considered suitable for retail clients by his firm – a local competitor has marked all such instruments as unsuitable for non-professionals.
“We often have non-professional clients wanting to buy some of our mortgage bonds and some that have been issued by the competitor, but because different firms are taking different views on the same thing we have to spend time going through the documentation,” he said. “It’s slowing down the process, and leaves a lot of room for mistakes.”
And in Sweden at least, non-professional does not mean retail – corporates are also caught by the same label, cutting off significant segments of the investment community.
He added that his firm has lobbied regulators on this point since 2015 to no avail, and is now working to persuade the competitor to change its specified target market for collateralised mortgage bonds.
Regulators are looking closely at the issue as it concerns the end investor, but no one is holding their breath for an immediate solution – so it may well be a market-led approach that solves it.
Priips: liability
In the run up to the January implementation deadline, some manufacturers were concerned about the point of liability. The lawyer said a question he has been asked repeatedly is: if I mark my Priip as unsuitable for retail clients but it later ends up in the hands of a retail investor via the secondary market, am I liable?
This is a point even trade associations have struggled to reach agreement on.
“For any new products that are created after Priips is implemented, manufacturers can obviously put something in the terms specifying who it’s suitable for,” said another source. “But for products that have already been sold, I suppose there’s not necessarily anything stopping brokers from selling it to whoever they want.”
Some manufacturers had hoped that trading venues or exchanges might include a form of disclaimer specifying that certain products are unsuitable for retail or non-professional clients. But Gerard Scully, director of international primary markets at the Irish Stock Exchange said in an email in December that that this would not be “necessary or appropriate” for an exchange to include such a disclaimer.
As manufacturers do not need to produce a KID for products listed on regulated markets when defined as unsuitable for non-retail investors, he explained that “it would therefore seem necessary for the product to be clearly labelled for non-retail, and it would be the responsibility of the intermediary selling the product to ensure it is suitable and appropriate for the investor”.
Priips: scope
The sheer scope of products, particularly in the fixed income space, caught some firms off-guard during the final stages of implementation in December. A derivative is believed to be packaged – though the fixed income source thinks further clarity on where derivatives fit into the regime should still be provided – while a fixed income coupon is clearly not. But a bond with a floor could be, much to the surprise of some in the market.
And charity bonds – even if they have a coupon – are deemed packaged purely because they are issued via special purpose vehicle.
Ultimately a huge amount of products sit in the grey area, and it will be a period of trial and error before the market gets comfortable – and it’s far more likely to be the retail space hit than the more exotic products bought by institutional investors.
“Whether it’s Mifid II or another regulation or something else altogether, I think we’ll definitely see a consolidation in the retail products space,” said Alexandra Foster, head of insurance, finance and payments and post-trade at BT, which is providing a range of data and communications services to market players across the Mifid ecosystem. “Although investor choice was a key tenet of both sets of rules, that’s just one of those many unintended consequences.”