The EU Maelstrom Gives Birth to Yet Another Headache

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  Thomas Wulf
  

Until the end of May, most people following EU developments still hoped that the Retail Investment Strategy (RIS) would be derailed by some divine or institutional intervention. The asset management associations of five major EU countries stirred into action at the last minute and, in a desperate effort, begged their ministers of finance to vote against the roughly 150-page legislative package put forward for approval at the last Council meeting under the Cypriot Presidency. Finally, though to no avail. Only Poland had the guts to vote against it, standing by what its government has consistently and unusually bluntly maintained in the many working group. 

Their point was that, most definitely, the last thing the EU’s internal market currently needs is another heap of red tape making selling financial products to private investors even more complicated and administration-heavy without addressing any of the underlying reasons why EU small investors are so reluctant to invest. 

Despite many interventions from national governments and other stakeholders outside industry circles, the hard-to-argue buzzword of “value-for-money.” was made the holy banner under which the Commission services would go on a crusade for an agonizing 36 months. They were, until the last weeks of negotiating the RIS package, hoping to find a magic formula that would allow them to calculate across payoff features, investor preferences, and product wrappers, whether a financial product was “worth the money invested” – but to no avail either. 

As has been pointed out many times, the mere idea that it could be possible to quantitatively evaluate each aspect of a financial product by benchmarking it against an abstract golden line or a peer group average to find “outliers” is widely seen as bound to fail given the myriad of aspects relevant for individual investors to be priced coherently. Such a concept is fundamentally rooted in an ill-guided thinking that dates back to the last decade of the previous century when the Commission tried to cover up whatever differences there were with a one-size-fits-all solution in the endeavour to make things more European. What the Commission realized only very late is the fact that applying this approach in the complex field of retail products also undermines the work of many national regulators who are traditionally very active in this market segment. It did not contribute to ESMA’s enthusiasm on the file. 

All this being said,in the end what had been set in motion in Brussels could not be stopped. RIS is coming and we have to deal with it. We are waiting to see, in the area of banking products alone, more than 20 topical challenges addressed by secondary legislation in the format of the so-called Delegated Acts and, as some will remember from the PRIIPs Regulation of 2014, the famous Regulatory Technical Standards (RTS). Drafts for both will have to be prepared by the EU’s regulators (ESAs), led by the European Securities and Markets Authority (ESMA) and the  European Insurance and Occupational Pensions Authority (EIOPA), the capital markets and insurance ones. They will look into peer group comparisons, benchmark calculation, appropriateness and suitability refinements, risk alerts, pricing process governance, cost and charges disclosure as well as cross-border reporting among other matters. As yet, no one has an idea how this overload of information generated at the customer and regulatory end is to be sensibly collected, monitored and acted upon. When asking the question, one usually encounters shrugged shoulders and “AI?” as a standard response. 

When looking at the product through the RIS prism this edition is dedicated to, Actively Managed Certificates, a few issues quickly come to mind. 

First of all, AMCs are relatively unknown to the wider regulatory world. There have been discussions in France and Switzerland about this product type in the past while the instrument may actually be new to many other markets (and, thus, national regulators). One prime concern will obviously be to make sure investors understand what they are buying. Clear communication from the issuer and distribution side will be crucial to help retail customers understand that the active component of an AMC lies with the issuer-side recalibration of the underlying proprietary index that the AMC note tracks as a Delta-1 instrument and that it is not linked to the active rebalancing of a share portfolio as it is known in the case of funds. 

Should regulators not be satisfied they may impose specific wordings for the marketing material. This area may see increased scrutiny as the new RIS rules will lower the opt-out threshold from the MIFID retail client category from EUR 500,000 to EUR 250,000. Regulators will likely zoom in on products that are more frequent in the sphere of knowledgeable investors. 

But the far bigger issue is value-for-money. Although the exact methodology for the comparison of structured notes and the evaluation of their costs and performance against a peer group is not yet known under the current RIS framework (ESMA will have to come up with the draft for this), what we do know is that each recalibrating of an index will trigger costs. The crucial question will be to what extent such costs, which accrue over the lifetime of the product, may endanger the profitability for investors. Of course, recalibrations are (and should be) undertaken primarily to improve the underlying’s performance. However, regulators may quickly point out potential conflicts of interest, in particular if the fee policy for external advisors handling the index management is not sufficiently transparent. They may also feel tempted to question any situation where there was no discernible reason for or any impact of the recalibration of an index on the performance of the AMC. Clear internal rules – possibly reinforced through an association level industry agreement as it already exists in Switzerland – may help here to actively support the discussion at EU level.

Another challenge in the Value-for-Money debate lies hidden in the mentioned peer group comparisons, should it be decided in the final RIS implementation rules that such are required also for AMCs. There, the question inevitably arises whether the appropriate peer product for an AMC would be an actively managed fund rather than another (structured) note or bond instrument. Arguments can be made for both even though the ultimate decision may be quite significant for the market success of these instruments.

Last but not least, a brief word on the enforcement of all of the above. Once again, we can see a pattern typical for Brussels legislation – it all depends. While national acts transposing the RIS Directive may come into force realistically only with a delay of 30 months after the legal act has been published and the Delegated Acts have to be drawn up first, the PRIIPs related rules may come in a bit faster. However, also in this case, much depends on when the regulatory technical standards (RTS) comes into force and on subsequent transition periods. A silver lining of the otherwise grey RIS may be that these timelines should give the industry ample time to become actively involved in the debate. 

With that I remain, with relentless optimism and best wishes for the summer,

Your Brussels observer

Thomas Wulf

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Thomas Wulf
Secretary General of EUSIPA

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The views presented in this article are solely those of the author and reflect his personal opinion.