Costs and charges: the crossover between MiFID II and PRIIPs

Not long now – in less than 6 months’ time – both MiFID II and PRIIPs will become effective across EU Member States.

ESMA recently published a Q&A on MiFID II and MiFIR investor protection topics in which 14 new questions were added. These include new Q&As on costs and charges in relation to the overlaps of disclosure requirements under both MiFID II and PRIIPs.

The common driver for both regulations is investor protection and they both effectively talk about the provision of short and concise information documents for prospective retail investors to enable them to compare different products and acquire a better understanding of the risks behind them. However, MiFID II has a broader scope and “applies to firms providing investment services and firms that manufacturer or distribute financial instruments,” whereas PRIIPs focuses on “unit-linked funds, structured products and retail investment products.”

This article will draw out the main changes from this Q&A by examining the PRIIPs calculation methodology, use of publicly available data, aggregating costs and itemised breakdowns of costs and charges.

One question asks if the PRIIPs calculation methodology covers product cost components that need to be disclosed under MiFID II cost disclosure. ESMA clarifies that the PRIIPs calculation methodology captures all costs and charges incurred by a PRIIP, including:

  1. one off costs
  2. ongoing costs (e.g., transaction costs incurred when trading)
  3. incidental costs (e.g., performance fees). PRIIPs manufacturers can therefore provide all relevant information on an instrument’s cost components.

As this is the case, ESMA clarified further that an investment firm can fulfil its obligation under the MiFID II regime in relation to the ex-ante costs and charges of a financial instrument, e.g., using the PRIIPs annualised Reduction in Yield (RIY) indicator. However, it was highlighted that, in relation to the cost of the service, it is important that the investment firm adjusts the information about distribution costs for a specific situation, depending on whether the amount is known or not, to provide the investor with the correct cost figures.

Question 8 explains that the PRIIPs cost methodology does not apply to products that are not packaged, e.g., corporate shares or sovereign bonds. It is expected to be used for packaged products that are not sold to retail investors, e.g., an alternative investment fund that is only available for sale to professional clients.

Additionally, to apply the PRIIPs methodology to a financial instrument, investment firms can use publicly available data, but are expected to liaise with the manufacturers (or the UCITS manager/manager of a non-UCITS fund) for data that is not publicly available and is needed for disclosure. If an investment firm is unable to obtain relevant data from the manufacturer, it must assess whether it can make a reasonable and accurate estimate of the total costs of the financial instrument. If so, it may use this estimate to calculate the ex-ante and ex-post figures on costs and charges.

Firms need to aggregate costs and charges relating to the investment service and the financial instruments under article 24(4) MiFID II and article 50(2) MiFID II Delegated Regulation. Third party payments received by the investment firm should be itemised separately. Itemised breakdown should be provided at the request of the client at least at the level highlighted in Annex II MiFID II Delegated Regulation. This breakdown should be expressed as a cash amount and as a percentage.

Under the PRIIPs regulation, information on ex-ante costs and charges per individual PRIIP is provided via the KID. If there is no data available on incurred costs to provide ex-ante disclosure – which could be the case during the first year after MiFID II has become effective, when an investment firm has just started business or in the case of new clients – firms should make reasonable estimates of the expected costs and charges. ESMA considers an estimate to be reasonable when it includes all variables that directly impact the costs and charges.

As discussed in one of JWG’s recent MIG meetings, the provision of ex-ante disclosures may be an operational challenge to provide reports in good time for certain products, e.g., those in the FX market, therefore, greater clarity on how this will work in practice is needed.

Disclosure requirements in both regulations are slightly aligned. This highlights the fact that firms should not treat regulations separately, especially with those that have close implementation dates. Instead, they should approach them using themes, as there can be overlaps between other regulations, like there are with MiFID II and PRIIPs. Where there are no overlaps, firms should comply with what is required under that particular regulation.

This approach is taken in our MIG meetings, with discussions held regularly on different areas under MiFID II and the crossovers with different regulations. Our next three MIG meetings are:

  • 22 June 2017 – MIG 89: Research guidance review 1
  • 29 June 2017 – MIG 90: Algo/HFT implementation note meeting 2
  • 4 July 2017 – MIG Suitability and Appropriateness guidance note call 1.

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