At the start of 2018, the EU introduced new legislations to make investment funds completely transparent. This is what those in the financial market may now know as Market in Financial Instruments Directive (MiFID II) and the Packaged Retail and Insurance-based Investment Products (PRIIPs).
With the use of these two regulations, all costs and charges involved in an investment process are to be fully disclosed. The objective behind the newly changed legislation is to help consumers assess the value of investment service before committing to an investment. For wealth managers, this means that they can assist their clients in making more informed investment decisions based on the charges and total returns of a given investment product or fund.
In this article, we will take a deep dive into what asset managers can expect from MiFID II and PRIIPs, and how these can be used to better serve their clients.
Understanding MiFID II and PRIIPs
At the core of the EU legislation is investor protection. For asset managers, this means that investors are to have access to specific information that assists in gaining a better understanding of the comparable products and the risks they pose. Although MiFID II and PRIIPs are similar in this regard, it’s vital that their differences are highlighted.
Let’s first take a look at PRIIPS. PRIIPs is built around packaged retail and insurance-based investment products – think unit-linked funds or retail investment products. The goal here is to enhance the protection standard for retail clients.
On the other hand, MiFID II has a broader approach to investment that applies to firms who provide and manufacture or distribute financial instruments. Here, equities, commodities, debt instruments, and exchange-traded funds (among others), fall under its jurisdiction. The aim of this legislative framework is to standardise EU practices following the financial crisis in 2008.
One of the largest points of difference between these two frameworks lies in the specifics. While PRIIPs discloses the risks, costs, and the possible ROI of products, MiFID II covers everything from transparency to product governance. In other words, MiFID II requires more work and ongoing attention from advisors to ensure compliance.
Key Aspects of MiFID II and PRIIPs:
Despite the differences, there are areas of overlap that all firms or individual asset managers need to take into consideration. By developing a strategy for these key aspects, they will be able to take on these new regulations and produce a service that’s beneficial on compliance, service, and final outcome levels.
Transaction Costs
Both PRIIPs and MiFID II require product cost disclosures. While PRIIPS takes on a clearer direction of which costs should be disclosed, MiFID II is less formulated. In fact, the latter doesn’t set out a specific formula to which firms must comply. This means that different approaches to calculating transaction costs can be taken.
However, despite these differences, these two frameworks need to disclose the following:
- One-Off Charges
- Ongoing Charges
- Transaction Costs
- Incidental Costs
These costs must be disclosed in each of pre-sale and annual reporting based on the investor’s personal level of investment. Furthermore, these figures should be listed in monetary and percentage values.
It is also important to note that transaction costs can be calculated differently. Mainly, these calculations are made up of the arrival price, execution price, and arrival cost strategies. It’s recommended that all firms and individual asset managers find a methodology that proves to be effective based on their needs and findings.
Performance Scenarios
Although these regulations require a performance scenario evaluation, they do differ in their approach. PRIIPs requires firms to produce a range of performance scenarios that are designed to show investors the potential growth of their investment under various market conditions. This takes on a more forward-looking approach than what was introduced in earlier years.
However, with MiFID II, forward-looking performance scenarios can only be done in specific standardisations. For this type of performance scenario evaluation, asset managers are not to base forward-looking performance off of past transactions and these must be based on reasonable assumptions. In these findings, advisors are to include warnings about the unreliability of the data and to take into consideration the impact of costs, fees, and charges. Furthermore, positive and negative performance periods must be used.
Risk Disclosure
Regardless of which regulation asset managers work with, disclosure of risk must be calculated in order to pass the ‘fairness’ test. For PRIIPs, this is meticulously outlined where the specific language is to be used and a Summary Risk Indicator is to be calculated with a continual review. MiFID II, however, doesn’t prescribe particular measurement calculations but it does require that one should be developed.
Whichever case asset managers find themselves in, written policy regarding the risk disclosure plan should be documented.
Timing and Document/Data Delivery
With the EU’s latest asset regulations, managers are required to deliver key facts and information before the investment contract is issued in order to be fair and clear.
With PRIIPs, financial advisors are to provide a KID report as well as specific threshold pointers regarding performance scenarios. This data must then be regularly reviewed and when changes are needed, a new KID should be promptly republished.
Under the MiFID II regulation, a less stringent approach is taken. Here firms are required to maintain and operate continual reviews for each approved product before it’s offered to an investor.
What are the Implications for Firms and Asset Managers?
Although PRIIPS and MiFID II regulations now apply, further guidance from European authorities can be expected as they address some of the issues raised by firms. While these details are being streamlined and perfected, firms need to ensure that they comply regardless.
Firms and asset managers are urged to ensure that all documentation is compliant and user-friendly in meeting the requirements of the legislation. This includes:
- Presenting easily accessible information on costs and charges
- Explaining the calculations of various costs and charges, as well as how they might be compared
- Warning consumers about data limitations and reducing any areas of potentially misleading information