COMMISSION STAFF WORKING DOCUMENT

IMPACT ASSESSMENT

Accompanying the document

Proposal for a Regulation of the European Parliament and of the Council on

key information documents for investment products

TABLE OF CONTENTS

1........... Introduction. 5

2........... Procedural Issues. 6

2.1........ Genesis of work. 6

2.2........ Consultation of interested parties. 6

2.3........ Supporting work. 7

2.4........ Related initiatives. 7

2.5........ Impact Assessment Steering Group. 8

3........... Problem definition. 10

3.1........ Size of EU retail investment markets, their regulation, and the policy context 10

3.2........ Problem drivers. 13

3.2.1..... Driver 1: Proliferation of product types aimed at same investment needs. 13

3.2.2..... Driver 2: Patchwork of regulation. 14

3.2.3..... Driver 3: Failures to effectively mitigate asymmetries of information between retail customer and the industry 17

3.3........ Scale of the problem and consequences. 21

3.4........ How would the problem evolve without further action?. 24

4........... The EU's right to act and justification. 25

5........... Objectives. 26

5.1........ General and specific objectives. 26

5.2........ Operational objectives. 26

6........... Options. 27

6.1........ Identification of options. 27

6.2........ Analysis and comparison of options. 32

6.2.1..... Issue 1 – What scope of products should be covered?. 32

6.2.2..... Issue 2 – How far and in what ways should disclosures be standardised at EU level?. 34

6.2.3..... Issue 3: Responsibility for preparing document 38

6.2.4..... Issue 4: Ensuring effective provision of product disclosure information to retail investors. 39

6.2.5..... Issue 5: Flanking measures: civil liability and sanctions. 40

6.3........ Summary of retained options and their interaction with the current legal framework. 42

6.4........ Choice of the legal instrument – directive or a regulation. 45

6.5........ Overall impact of retained options. 46

7........... Impacts on other stakeholder groups, employment, SMEs, environment and third countries. 50

7.1........ SMEs. 50

7.2........ Employment and social impacts. 50

7.3........ Environment and third countries. 51

7.4........ Administrative burden. 51

7.5........ Risks and uncertainties. 51

7.6........ Monitoring and evaluation. 52

8........... Conclusions. 52

Annex I

1........... List of Acronyms. 54

2........... Related Initiatives. 55

3........... What are packaged 'retail investment products'?. 57

4........... How big is the market for packaged retail investment products?. 59

5........... How are packaged retail investment products distributed?. 59

6........... European disclosure rules for retail investment products. 62

7........... Member State approaches to the regulation of retail investment products. 67

8........... Evidence on issues for retail clients from 2008 Call for Evidence. 68

9........... Nature of product disclosures and their relationship with the sales process. 71

10......... The Lamfalussy process. 73

Annex II

1........... Detailed analysis of options. 74

1.1........ ISSUE 1: What should the scope of any new regime be?. 74

1.2........ ISSUE 2: How far and in what ways should disclosures be standardised at EU level?. 76

1.3........ ISSUE 3: Responsibility for producing document 85

1.4........ ISSUE 4: Ensuring effective provision of product disclosure information to retail investors. 86

1.5........ ISSUE 5: Civil liabilities and sanctions. 88

2........... Estimation of administrative burden. 93

3........... Possible impacts of horizontal PRIP act on existing sectoral legislation. 96

1. Introduction

The focus of this impact assessment is product disclosures in the retail investment market.

This market is dominated by so-called ‘packaged retail investment products' (PRIPs) – financial product manufacturers intercede between retail investors and financial markets, building products normally designed to satisfy specific investment goals, with the intention of being sold to retail investors either directly or through intermediaries. Examples of PRIPs include investment funds such as UCITS, retail structured products and unit-linked insurance contracts.

To protect investors, measures have grown up at the national and EU level that require defined information to be provided to retail investors (termed ‘product disclosures’). These measures are however uncoordinated and patchy – requirements vary according to the legal form of products, not their economic nature or risks. This has made comparisons between products and comprehension of product features harder for investors. The measures have also not achieved the outcomes being sought for retail investors: product disclosures have often focused more on reducing legal risks for the provider rather than providing effective and balanced communication about products.

In its April 2009 Communication on PRIPs, the Commission concluded that this was an important problem with a European dimension: inconsistencies at the European level underpinned regulatory failings, which could only be addressed by legislative change at the European level.[1] (The Communication noted two areas of further work: rules applying to sales, and rules on product disclosures. This impact assessment focuses on the latter only[2]).

Addressing these regulatory failings also contributes to responses to the financial crisis. Following the crisis retail investors lost money with investments that carried risks that were not transparent or understood by those investors, partly due to deficient product disclosures. There has, perhaps rightly, been a consequent collapse in investor confidence: a recent survey of consumers across the EU showed they trust the financial services less than all other industry sectors.[3]

Addressing weaknesses in product disclosures will help rebuild confidence on a sound basis, improving the transparency and efficiency of EU retail markets.[4] Innovative steps have already been taken along these lines to improve product disclosures for UCITS (through the 'key investor information' (KII) regime).[5] The task now is to address options for similar improvements for other investment products.

2. Procedural Issues

2.1. Genesis of work

The genesis of the work on PRIPs is a request from the ECOFIN Council in May 2007 for the Commission to examine the coherence of disclosure and distribution regimes in EU law applying to different types of retail investment product. A first stage of work culminated in the adoption of a Communication on PRIPs by the Commission in April 2009. This was accompanied by a high-level impact assessment (hereafter, PRIPS Communication IA).[6] Following the Communication, the Commission has been further consulting with stakeholders. The work has been split into two workstreams – the current workstream, focused on product disclosure requirements, and a second workstream focused on sales rules.

2.2. Consultation of interested parties

The PRIPs work has been based throughout on extensive consultation with stakeholders, including a written call for evidence in October 2007, a Feedback Statement in March 2008, a technical workshop was held with industry representatives in May 2008, and a high-level Open Hearing in July 2008. Following the Communication, a second, more concrete phase of work and consultation began. A further technical workshop was held in October 2009, which was followed by the publication of an Update on the work in December 2009. The three level three European committees of national supervisors prepared individual reports to the Commission in 2009, followed by a joint report in 2010. Finally, the Commission launched a public consultation on concrete options in November 2010.

Records of these phases of consultation, which respected the Commission's minimum standards on public consultation, are available on the European Commission website.[7] In general, responses to the November 2010 public consultation showed support from industry, consumer and Member State stakeholders for the initiative, though there were differences of view on the scope of the work and the extent to which the UCITS KII might be taken as a model for other retail investment products.

Table 1: Preparatory Steps

Major steps / inputs || Timing

ECOFIN request || May 2007

Launch of Call for Evidence || October 2007

Publication of Feedback Statement on Call for Evidence || March 2008

Industry Workshop || May 2008

Open Hearing || July 2008

Communication || April 2009

CESR, CEBS, CEIOPS advice || October 2009

Technical Workshop || October 2009

Update || December 2009

Joint CESR, CEBS, CEIOPS advice || September 2010

Public Consultation || November 2010

These formal events have been supplemented by a series of discussions with consumer representatives (FIN-USE, Financial Services Consumer Group, and Financial Services User Group), regulators (Financial Services Committee, European Securities Committee, European Insurance and Occupational Pensions Committee) and industry representatives. The consultation process revealed a variety of stakeholder views, which have strongly informed the analysis that follows.

2.3. Supporting work

The following supporting work informs this impact assessment:

· A report produced by a joint task force of the level three committees. (3L3 Report).[8]

· A study on the costs of implementation of the KIID for UCITS. This study provides a proxy (subject to adjustments) for costs of other industry sectors for introducing similar disclosures for their products. (CSES).[9]

· A study testing developing options for the KIID for UCITS on a representative sample of EU consumers. (YouGov & IFF).[10]

· A study seeking behavioural economics insights on the different factors relevant to investor decision making. (Decision Technology).[11]

· A study on the potential costs and benefits of different options for change in the area of sales rules for the distribution of non-MiFID PRIPs; this provides market mapping evidence and also evidence on cost drivers, though its focus was primarily on product distribution. (Europe Economics).[12]

· A study seeking to assess the quality of advice being offered across the EU; this provides some market mapping evidence. (Synovate).[13]

2.4. Related initiatives and scope of this impact assessment

There are a number of related initiatives that link to the work on PRIPs product disclosures, or can be expected to benefit EU retail investors.

These include the review of the Markets in Financial Instruments Directive (MiFID), the review of the Insurance Mediation Directive (IMD), work on the Prospectus Directive (PD), current work in the area of asset management (notably in relation to Alternative Investment Funds, but also the implementation of UCITS IV), ongoing work on Solvency II, the Commission Green Paper on pensions, and upcoming work by the Commission on the Single Market Act. Other work underway can be expected to impact the retail investment markets, notable work on the protection schemes for investors when those providing investments are not able to meet their commitments to investors (deposit guarantee and investor or policyholder compensation schemes).

The baseline for this impact assessment takes into account the likely evolution of measures in these other areas.

Scope of the impact assessment and key interactions

This impact assessment is focused solely on options relating to improving information given to investors about PRIPs (their risks, costs and features).

This impact assessment does not address options related to sales of PRIPs. This area, identified in the Communication on PRIPs as a second priority alongside product information, relates to investor protection measures for investment advice and sales services. Options for improving such rules are being considered and assessed separately in the reviews of MiFID and the IMD.

The identification of options for improving product information and assessment of the impact of these can be undertaken independently from measures on sales, since the subject matter, impacted entities and underlying regulatory and market failings are separte and there are no necessary dependencies between the two areas.

Measures on disclosure and distribution can expected nonetheless to be mutually supportive, and indeed their contribution to addressing problems in the retail markets can be expected to be greater in combination than in isolation. Given this, the assessment of options and their overall effectiveness and efficiency in this impact assessment takes into account relevant synergies, and this impact assessment should be read alongside assessments of options for the IMD and MiFID.

Details on linked initiatives can be found in Annex I.2.

2.5. Impact Assessment Steering Group

An Inter-service Impact Assessment Steering Group, chaired by DG Internal Market and Services, was established in November 2010, involving representatives from DG Competition, DG Taxation and Customs Union, DG Justice, DG Economic and Financial Affairs, the Secretariat General, the Legal Service and DG Health and Consumers. The Group met on 26th October 2010, 2nd February 2011 and 2nd March 2011.

The draft impact assessment report was examined by the Impact Assessment Board, and revised in line with its positive opinion of 15 April 2011. Amongst other improvements, the interaction between the proposal and other measures on investor protection was clarified, the scope of the proposal made clearer, the analysis of options improved and the analysis of other factors that are relevant for investor decision making deepened.

Problem Tree

Retail packaged products offer similar economic contents but using different legal forms

Patchwork of regulation Divergent EU and national approaches Gaps in regulation

Unmitigated asymmetries of information between retail investors and market participants

Unlevel playing field

Barriers to single market

3. Problem definition

This chapter should be read in conjunction with the 'problem tree' on page 9.

The analysis builds on the impact assessment completed for the April 2009 PRIPs Communication (hereafter, PRIPS Communication IA). This identified the broad market context and problem drivers for this initiative. It showed that existing regulatory requirements in the retail investment markets failed to fully address 'information asymmetries' (i.e. differences in comprehension of proposed investments between market professionals and retail clients) and 'principle-agent' misalignments (i.e. those manufacturing and selling products have incentives that are not always aligned with those of the retail clients buying the products). The patchwork of European regulation had failed to effectively reduce consumer detriment, and acted as a barrier to member states addressing such detriment themselves, while at the same time creating an un-level playing field between different products and distribution channels and erecting additional barriers to a single market in financial services and products. EU legislation was a source of the problem, so legislative change at the EU level was necessary to effectively and efficiently address these challenges.

Two strands of work were identified: improving consistency and effectiveness of the information about products from product providers, and improving consistency and effectiveness of the rules on distributors.As noted, this current impact assessment only addresses the first of these two strands of further work triggered by the Communication: product disclosure.[14]

3.1. Size of EU retail investment markets, their regulation, and the policy context

Size

There is currently no definition of the retail investment markets with the EU. If we understand this concept as the market for investment products that can (and typically do) reach the retail customer, a wide range of products can fall into this category. Examples include funds of various types, unit-linked life insurances (and other investment-based insurance products), shares and a miscellany of other kinds of products that might be characterised as 'retail structured products'.

Given that the boundaries of this market are not currently determined under EU law its magnitude can only be estimated. At the end of 2009, the European asset management industry managed assets worth around €9 trillion in investment funds.[15] Of this, EFAMA estimate that roughly €3 trillion had been contributed directly by retail customers; a part of the remaining €6 trillion will also be ‘retail’ due to intermediation (where third parties intercede between the fund and its end clients so the fund cannot determine the classification of the end client), but it is difficult to assess the scale of this.[16] Looking at the insurance sector (which offers a variety of products that provide retail investment benefits), CEA data from 2009 shows insurers holding overall investments in the range of €5 trillion (these investments cover savings and pensions but also funds backing pure insurance products, some of these investments will be institutional holdings of funds such as UCITS; around a third can be roughly estimated to be held in as unit-linked life insurance).[17] Data providers linked to the retail structured product market suggest that structured products taking securities and deposit forms amounted to less than €0.5 trillion in 2009. This suggests an overall market of over €9 trillion in 2009, with a breakdown according to Graph 1.

Graph 1: Estimate on PRIPs market breakdown, 2009

Source: EFAMA, CEA, Arete Consulting; these figures do not distinguish between retail or institutional business

The Decision Technology study surveyed householders and found roughly a split of around 36% cash, 7% funds, 13% shares, 4% fixed income, and 37% insurances. However these figures are self-reported by respondents, and the precise makeup of different categories is difficult to assess, so these figures may not be reliable.

The market in general appears to be dominated by funds and insurance-based investment or savings products, with structured products currently taking a relatively small slice of the market. The Decision Technology survey suggests however that households maintain significant holdings in the form of cash or deposits (which fall outside of the retail investment market in this impact assessment).

Box 1: What are PRIPs?

In simplest terms, a PRIP is an investment product sold to a retail customer. This captures the three key concepts: first, the term 'investment product' captures the two key criteria that define PRIPs. As investments, they are propositions that expose the investor to risks; the investor provides capital (whether in a lump sum or through regular savings), and the investment promises returns on this capital. As products, they are 'manufactured' by financial services intermediaries, who construct the propositions to provide cost effective access to investment propositions for retail investors who otherwise would have neither the expertise or access to make such investments. Secondly, the prescence of a retail customer. Measures designed to address the needs of retail customers may not be relevant for professional customers.

The Commission has consulted on options for defining PRIPs, including distinguishing them from ordinary savings products (that do not carry investment risks) and sought input from miscelaneous studies, so as to ensure coherent requirements apply to all the products of relevance, irrespective of their legal forms, as set above in sections 2.2 and 2.3.

The results from this consultation have informed the identification of options on scope and assessment of their impact in section 6.2 below.

Regulatory context

Regulations on product disclosures address, in particular, the needs of investors for information on the nature, risks, costs, and possible performance of specific products.

Such regulation sits within a wider context, both nationally and at the level of EU laws, with other rules covering areas such as distribution and sales, including disclosures about distributors and their costs, prudential requirements (capital and solvency rules), and other sundry areas, such as rules on product providers to ensure they are capable of undertaking the business they engage in, and rules on redress and compensation schemes to ensure customers can obtain redress in relation to fraud or return of investments in the case of the failure of firms.

As will be discussed in greater detail below, regulation of product disclosures is currently patchy and inconsistent, with divergent approaches at the EU level according to the legal form a product takes (rather than its level of risk for the investor). Some Member States have sought to harmonise requirements cross-sector, in so far as EU legislation allows. In practice requirements placed on product manufacturers vary significantly between Member States: a CEIOPS survey concluded “there are a striking number of detailed additional measures [on pre-contractual disclosure], which are unique to individual Member States … suggesting that Member States have sought to be more prescriptive than the terms of the CLD in order to, for example, protect consumers”.[18]

The UCITS market – a significant proportion of the PRIPs market, and one with strong cross-border dimension – is currently implementing Commission KIID requirements. These are strongly prescriptive and standardised, and will introduce a common product disclosure document (with a simplified but objective risk rating) across all EU markets for such funds. There are no comparable requirements for other products at the EU level under existing legislation.

Box 2: Role of product disclosures within a typical retail sales process

Most investments sold to retail customers in the EU are in practice sold through 'advised' channels (estimates vary, but Decision Technology survey suggests between 60 and 80% of sales might be generally described as 'advised').[19] Product disclosures have an important role to play in such sales.

Under an advised sale the intermediary gives a personal recommendation to the client as to possible suitable investments based on the client's needs and situation. The sales process typically will have two logically separate aspects. The first aspect relates to the sales process itself, and any services being offered by the sales person, notably the service of providing advice to the investor. The advisor would typically make disclosures to the customer about themselves, about the service they are offering, and about any fees associated with the service. Following discussions between the advisor and the customer, including gathering of information by the advisor, the advisor might typical make a recommendation, providing for instance a short list of products.

Product disclosures – the focus of this impact assessment – can be defined as the information provided to the customer at this point, information about the individual products being proposed. The purpose of these disclosures is typically to ensure comprehension of products including their specific risks and costs, and, in some cases, to enable investors to better compare between products.

(For a fuller discussion of the practical context of product disclosures, see Annex I.9).

3.2. Problem drivers

Three key 'problem drivers' underpin and structure the problems covered by this impact assessment (as already discussed in the PRIPs Communication IA):

· Driver 1: there is a proliferation in (often complex) investment products on offer to consumers, that take different legal forms and structures yet which offer comparable risk/reward profiles; yet

· Driver 2: these different products are regulated in different ways according to their legal form rather than their economic nature; as a consequence

· Driver 3: there are powerful asymmetries of information between retail customers and the industry which remain unmitigated.

These drivers are not independent. Drivers 1 and 2 contribute to Driver 3.

3.2.1. Driver 1: Proliferation of product types aimed at same investment needs

The key types of PRIP identified through earlier consultation and impact assessment are:

· Funds (whether UCITS or non-harmonised, covering both open-ended or closed-ended structures);

· Investments packaged as life insurance policies (notably, unit-linked, index-linked and certain other 'with-profits' products); and

· Retail structured products (typically in the form of structured securities or structured term deposits; so-called 'structured' products also in some markets have taken the form of funds or life insurance policies).[20]

Earlier market mapping by the Commission, responses to consultation, and discussions with stakeholders have underlined that functionally similar investment products are increasingly manufactured ('packaged') using a variety of legal forms, with similar investment propositions being offered across different industry sectors. This 'packaging' of products can make them appear very different for investors, even where underlying economic purposes are similar (e.g. a fund, a deposit and a unit-linked insurance contract look different, but might be equally used to have the same investment exposuire, for instance to a particular stock index).

There is a potentially bewildering variety of products; for instance, during 2009 there were over 274000 tranches of retail structured products brought to market and 36000 UCITS funds for sale.[21] Factors leading to a proliferation in types of product could include differences in tax treatment, regulatory arbitrage, and nationally specific market traditions. Yet all of these products seek to address a relatively simple need: capital accumulation by taking on risk so as to have the potential for beating a risk-free rate of return. While these products vary in what they offer – some combine the prospect of capital accumulation with a capital guarantee, while others do not; some combine an investment element with another element (such as offering life insurance benefits) – they all are offered as investments to retail customers when they approach financial intermediaries or directly product manufacturers.

Responses to the PRIPs consultation, including product providers, supervisors and consumer representatives, support the view that the product types identified above are broadly competing for the same investments of the same retail customers, offering similar investment propositions but packaged in different ways. Respondents have generally agreed that the identified product types above between them make up the vast bulk of the retail investment market as it currently stands, though a number have noted that other possible competing products or investments might emerge. Some consumer representatives and national supervisory authorities have argued in favour of widening the perspective on competing or substitutable products to include deposits and simple savings accounts, which are subject solely to interest rates. Also, some consumer representatives and national supervisory authorities took the view that 'unpackaged' assets (such as ordinary corporate equities or bonds) should be subject to the same disclosure requirements as those that are packaged. More technical views have also been raised over the details of where the 'line' between investments and products serving other client needs might sit, particularly for products which combine investments with other elements. In addition, there has been debate over the extent to which pensions (notably, personal pensions, or ‘pillar three’ pensions) might be considered to be competing with other retail investment products, and whether or not these might be included or excluded with the PRIPs initiative.

Nonetheless, despite differences over technical 'boundary' issues, consultations with stakeholders have revealed a general acceptance that investment products with different legal forms are currently competing with one another, and that these legally different products raise, despite their differences in form, similar needs for clearer information on costs and risks that is capable of comparison between types of products.

3.2.2. Driver 2: Patchwork of regulation

European and national regulation on product disclosures already applies to most products (structured deposits excepted).

However, Community law has developed on a largely sectoral basis, at different speeds and with different outcomes in mind. As a result, the rules governing what disclosures need to be prepared and what these should look like vary materially according to the sector in which the product is originated and in which an intermediary operates.

Notably, most disclosure regimes are relatively high-level and do not set out in detail the form and content (or the 'look and feel') of product disclosures. The UCITS KIID regime is an important exception: this regime is very prescriptive and detailed, and was developed to ensure disclosures in a short and investor-friendly manner capable of supporting comparisons between funds (including those sold cross-border).

The following table illustrates this 'regulatory patchwork'; see Annex I.6 and I.7 for further details on the contents of the different existing regimes, and a summary of certain national requirements that also apply to firms in this area.

Table 2: Disclosure rules and intermediary regulation in Community law for packaged retail investment products

|| UCITS || Other Open-Ended Funds || Unit-linked life insurance policies || Structured securities and closed-end funds || Structured term deposits

Rules on product information applying to manufacturers, issuers or intermediaries || Key Investor Information (KII) of UCITS Directive || MiFID (high-level product disclosure requirements apply to MiFID intermediaries when selling financial instruments) || Solvency II (CLD rules) || Prospectus Directive[22] || No rules at EU level

MiFID[23] (high-level product disclosure requirements apply to MiFID intermediaries when selling financial instruments) || Insurance Mediation Directive[24] for some product disclosure requirements || MiFID (high-level product disclosure requirements apply to MiFID intermediaries when selling financial instruments)

E-commerce Directive or Distance Marketing of Financial Services Directive

This patchwork must also be understood in the context of developments at the national level. Member States have approached the retail investment market in different ways, to the extent that EU legislation affords them discretion (notably for products other than UCITS). The IMD and Consolidated Life Directive (CLD, now Solvency II) rules are not maximum harmonising, permitting national rules that are more strict; however, CEIOPS mapping work shows that the national approaches to product disclosures for unit-linked life contracts that have emerged on the basis of the IMD and CLD are not comparable with or consistent with the KII envisaged by the UCITS Directive, with strong divergences in national approaches.[25] Requirements thereby diverge strongly cross-border for non-UCITS PRIPs (an issue raised by some industry stakeholders to the Call for Evidence and PRIPs Consultation).

While common prospectus rules (under the Prospectus Directive) govern part of the structured product market, these rules are not comparable to the KII rules for UCITS (see Annex I.6 for more detail), while prospectus information may not be used by distributors in practice for informing retail clients when buying such structured products (given the complexity and length of such disclosures, and the fact there is no requirement on distributors to provide the prospectus). National rules vary in regards information provided by the distributor about such products.

Key problem 1: An unlevel playing field develops between product manufacturers

A regulatory patchwork can lead to increased administrative costs and regulatory arbitrage.

Different levels of regulatory requirements can create an incentive for products to be structured and marketed to take advantage of less onerous requirements – often within one Member State, across product groups; but potentially even across borders. Product proliferation has been indicated by some stakeholders, including consumer representatives and national supervisors, as providing prima facie evidence of regulatory arbitrage.[26] Ongoing work has begun at the level of the European Supervisory Authorities on financial innovation in relation to retail investment products in reaction to these concerns. It is difficult to assess the extent to which differences in transparency requirements are a sufficient motivation on their own for driving market entry or exit, however they are likely to be one factor.

In relation to administrative costs, a number of consultation respondents from the industry commented that duplication, overlaps in requirements or differences in requirements both sectorally and between Member States (where they operate cross-border) potentially raise administrative costs and reduce competition across markets. They noted that a lack of clarity as to content of regulatory requirements and associated liabilities could also lead to greater compliance costs for firms (for instance, through the need to contract for legal advice).

For UCITS, defining cross-border business can be tricky (given complex delegation arrangements by management companies related to funds); however, the fact that 41% of assets under management are domiciled in Ireland and Luxembourg indicates the high degree of cross-border business.[27] There are no indications of similar degrees of cross-border business for other PRIPs; for instance estimates put total cross-border insurance business at 4 to 5%.[28] Even if the cross-border sales of non-UCITS PRIPs are not so significant, the current legal patchwork poses a threat in two respects: first, the existing internal market in UCITS is subject to direct competition from products that are less strictly regulated in regards product disclosures – or not regulated at all. Second, the current differences in disclosure requirements are likely to be perceived both by investors and by industry as a fragmenting factor along national borders, which do not help any future positive development towards market integration.

Key problem 2: Increased barriers to the further development of the single market

As noted, most PRIPs are not currently sold cross-border in great volumes, with the notably exception of UCITS. A regulatory patchwork of product disclosure requirements is one barrier to further cross-border business across different product types. The impact of national differences over product disclosures was strongly highlighted by UCITS stakeholders (prior to the development of the KIID), who identified such differences as a key barrier to further development of cross-border efficiencies.

Failures to effectively mitigate asymmetries of information at the EU level have encouraged action at the national level to address emergent problems, and the financial crisis has led to such action being more likely in the absence of further steps at the EU level. Such action at the national level is necessarily uncoordinated, leading to increased differences in approach across Member States. In addition, current sectoral differences in requirements at the EU level encourage Member States to address issues on a purely sectoral basis.

In addition, given the UCITS KIID, in the absence of further EU action some Member States can be expected to seek to improve disclosure requirements for other investment products, but in an uncoordinated way. It is difficult to assess the likelihood of this, but it is important to stress that the technical details of how one extends UCITS KIID-like rules to other segments are major drivers of compliance costs, which means that coordination on this could be a significant means for preventing the build-up of further regulatory barriers to market access.

3.2.3. Driver 3: Failures to effectively mitigate asymmetries of information between retail customer and the industry

The financial services are difficult to understand even for professional market participants. This is in large part due to their intrinsic complexity (exacerbated by drivers 1 and 2). This complexity can take different forms with different consequences.[29] Low levels of financial literacy and capability undoubtedly compound these issues – these however are out of the scope of the current analysis and will be / are being addressed elsewhere.

In addition, for many retail customers there are few opportunities to learn from experience in retail investment markets: customers typically do not engage repeatedly in investment activities, but do so only in relation to certain specific and widely-spaced life events (inheriting money, or investing towards a specific future liability or goal, such as buying a house, retirement or family planning).[30]

Existing regulatory requirements (driver 2) are designed to mitigate asymmetries in information.[31] However, these are ineffective and inconsistent, and a proliferation in new products and market innovation (driver 1) have also led to products being offered in forms that were not envisaged during the development of the existing disclosure requirements.

This third problem driver can be divided into three specific components (sub-drivers):

1 -- Mandatory information currently provided is not sufficiently easy to understand

Existing retail disclosures about investment products have been very strongly criticised by a wide range of stakeholders, including industry, consumer representatives, trade bodies, and national supervisors.[32] There are a number of elements that contribute to perceived failings.

· Retail customers find financial services concepts and jargon are opaque, difficult to understand and unfamiliar. This is in a context where retail investors struggle to undertake even the simplest tasks (in the Decision Technology study, almost half of respondents failed to optimally allocated investments in a simple exercise).[33] Everyday connotations of words complicate the picture: the concept of 'risk' has strongly negative connotations for retail customers, though the financial services concept of risk is not a wholly negative concept.[34] Great care is thereby needed to communicate with retail customers in a clear and effective way, yet documents for retail customers often are written in a fashion that is only comprehensible for professional counterparts that takes no pains to communicate clearly with the typical or average retail customer. A lack of standardisation and thereby confusion between concepts, e.g., in language used to describe investments, can undermine trust, comprehension and comparability of information.[35] Responsibilities for communicating clearly are too often placed on others, with not enough ownership of such responsibilities by the senior management of the firms that produce investment products.

· Documents are very often too long, or suffer from 'information overload'.[36] Text and information is presented in a dense manner, without any effort to prioritise what is important or what is not. Text can appear to be simply a collection of 'caveats' or legal / contractual information; documents are too often written by lawyers rather than those trained in communicating effectively with retail customers. Key information can be hard to identify. A respondent to the UCITS KII put this well: '…documents are too long, so we just can't be bothered to read them from the beginning to the end'.[37] Financial services firms can take the view that making information available – even if this is done in a manner that is not likely to be effective for the average investor – is sufficient to discharge their responsibilities for informing those investors.

· Presentation can often be dull, confusing or unengaging, suggesting the information provided is not vital or important, or that it is not likely to be understandable for the average reader. There can be a poor use of design techniques (e.g. white space, headings, emphasis, layering of information). A desk-based survey of disclosures in the UK showed that many of these were not as physically appealing or well presented as other marketing information, so as to undermine their importance and relevance for investors.[38]

· Finally, information provided may be partial or misleading in effect for the average investor, even if technically correct details are included in small print. Evidence included in the PRIPs Communication IA included the example of mis-selling of equity-linked insurance products in the Netherlands where costs were insufficiently disclosed. This problem can either be due to poor compliance standards, or due to more subjective factors related to the presentation of information and the positioning of key information in small print. For instance, one respondent to the YouGov and IFF study noted the problem of overly highlighted positives: 'they would only present beneficial features of the products…I should have read the additional information in the document but because it was written with small font I ignored it'; another remarked (in relation to a savings product) 'it was an account that I thought paid 5% interest a year, when in fact it was 5% over 2 years…I was just displeased…it was in the small print so really was my mistake'.[39]

Evidence on impact

The YouGov and IFF study showed that investor understanding of risks was very sensitive to details of the language used or presentation.[40] Other research has shown poor understanding of basic concepts of 'risk reward', and questioned the accessibility of even the basic concept of a percentage (%).[41] As another illustration, the Decision Technology study explored respondents (who had invested in the recent past) understanding of their investments, and found very strong evidence of very basic misunderstandings: for instance, nearly 40% wrongly believed that investments in equities they had made benefited from capital guarantees.[42]

This evidence (which is consistent with much other research in this area), and feedback from consultation respondents, has confirmed the findings of work on financial literacy: that average investors are currently poorly able to understand many of the investment products offered to them. Of course, failings by investors to understand investments are not solely a consequnece of poor disclosures. Low levels of financial capability are clearly relevant; also, where an investor seeks advice, the advisor takes responsibility for making suitable personal recommendations. Nonetheless, research on consumer use of information shows that respondents comprehension of information is sensitive to the presentation, comparability and clarity of the information..[43]

Ultimately, clear and understandable information is necessary (if not sufficient) for informed decision making. Improving information would therefore lead to improved decision making. In particular, the Decision Technology study shows that standardisation and simplification of information can drive such benefits.[44]

Key problem 3: Retail investors fail to understand the products they buy

2 -- Mandatory information currently provided is not comparable

The regulatory patchwork in EU disclosure requirements effectively prevents firms from providing consistent disclosure information to retail customers, which has the immediate consequence that it is difficult for those customers to compare different products.[45]

· General information about the nature and features of the product – what it is, how it works, how you can redeem it, how you can find out more about how it is doing – can be presented in very different ways, or use different classifications of investments or terms, making it difficult to compare.

· Information about risks is presented in incompatible or difficult to compare ways (this covers both market risk (price volatility), but also other dimensions of risk, such as counterparty risk or operational risk). When investors do try to compare information provided it can be misleading – it may be very hard to see what it truly 'low' or 'high' risk, and there is no 'objective' or neutral help available in assessing this.

· Different products have different costs and mechanisms by which costs are charged to the investor, and these costs can be presented in very different ways or according to different calculations.

Evidence on impact

Both the Decision Technology study and the YouGov and IFF study showed that presenting information in competing or different formats undermines investor comprehension and confidence. Both demonstrated startling failures on the part of investors to assess competing investment propositions. The YouGov and IFF study also showed that presenting risk information in a structured way capable of comparisons (i.e. placing each fund on a scale from 1 to 7) significantly improved the ability of investors to compare between funds, even where complex caveats might need to be taken into account.[46] Research by the UK ABI supports this finding.[47]

Failures to effectively compare products may be linked to the extent to which investors shop around for investments. Decision Technology found little evidence of extensive search behaviour in the retail investment markets; in part a lack of 'shopping around' might be related to infrequency of investment decision making, or self-perceptions of investors as to their confidence in making investment decisions.[48] A lack of comparability of information is likely to be one factor in limiting confidence, shopping around behaviour, and hence competition in the investment product markets.

While there is much behavioural evidence on difficulties investors have comparing costs, some important UK evidence supports a specific link between the introduction of regulatory steps designed to improve the comparability and transparency of costs and the manufacturer's future pricing of the products. Introducing a price comparator into product information (the so-called 'RIY' figure) where price information was otherwise complicated correlated with pricing changes in the market for life products that might not be explained through other factors.[49] This may indicate increased shopping around behaviour by customers or that firms themselves are choosing to compete on price (possibly in the anticipation that price was going to be of increased salience for investors). Other research also showed positive benefits to the inclusion of measures to improve price transparency into mandatory disclosures.[50]

Note that there are no equivalent measures to those for UCITS KII available for other PRIPs so as to facilitate comparisons between them and each other or UCITS. This may distort the market between UCITS and other PRIPs.

Key problem 4: Retail investors fail to compare products

3 -- Mandatory information is not made available to investors in a timely fashion

The best information disclosures would be of no value if they were not in practice read and used, or they were provided to investors too late in their decision making process to be of value in that decision making.

Evidence suggests that these problems – of actual provision or the timing of provision – are important. Notably, in the Synovate study, few participants recalled or recorded being provided with product information.[51] While there is an enforcement or compliance component to this issue there are also divergences in EU law in regards the standards that apply as to whether product information prepared by manufacturers must be used by intermediaries.[52]

The provision of information to investors is of course only part a wider picture: the information has to actually be used and read by the investor if it is to impact on their behaviour. Sub-drivers 1 and 2 contribute to information that is provided being unattractive or uninteresting, and consequently less likely to be read, which is why the three issues should be looked at and tackled together.

Key problem 5: Retail investors do not receive information

3.3. Scale of the problem and consequences

Investor side

Micro (individual) level

Investor detriment in the retail investment market can take different forms:

· Buying products which have a risk profile that is not suitable – i.e. where the risk/reward profile of the product is not understood or anticipated, leading to direct losses (e.g. during downswings, or where an investment has higher volatility than expected), or to opportunity costs (where an investor wishes to take on a higher risk/reward investment than they in fact purchased).

· Buying products with features that are not suitable (e.g. products which include a lock-in period during which it is impossible to redeem or where redemptions carry penalties). This can include paying for features that are not appropriate or necessary given the investors' needs.

The PRIPs Communication IA already surveyed examples of these problems in practice (summarised in Annex I.8). Looking across the EU market as a whole to assess a possible scale for mis-selling is complicated by the fact that mis-sales are not necessarily recognised as such at the time (or indeed later), so that possible effects on competition, pricing and opportunity costs are difficult to untangle. Issues typically arise where market movements expose a practice that had hitherto gone unnoticed; such problems have been distressingly common.[53]

The recent Synovate study provides a basis for assessing the EU-wide scale of these issues however. It concluded that around 60% of sales in a mystery shopping exercise across all EU markets might be deemed 'unsuitable'.[54] In this context, a number of aspects are certainly linked to non-compliance with existing point of sale rules (for instance, insufficient gathering of personal information about the client or superficial evaluation of suitability) while the study also noticed a significant proportion of advice focusing on products that are less regulated at the point of sale (for instance, certain savings products) which may indicate a form of regulatory arbitrage. However, the study also identified problems with disclosures concerning the products recommended to clients, which is the aspect of particular relevance in this context. In addition, the provision of clear and comparable information about products and their prices could be expected to contribute to greater salience being placed on product features and prices at the point of sale, impacting the scale practices related to these other factors.

Given the complex interaction of factors at the point of sale, estimating the specific contribution of product disclosure failures to mis-sales (especially where sales are accompanied by advice) is in practice difficult; the only reliable techniques are ex poste in nature rather than ex ante, and such data is not readily available across the whole EU retail investment market.[55] Where a personal recommendation is made, the quality of that recommendation will clearly be of key importance. External factors too can be important, including the impact of non-professionals (friends and family, for instance), or 'cultural' factors (such as brand loyalty).

Nonetheless, it is clear that poor transparency and reduced comparability of information contribute or enable mis-selling. Even taking into account potential caveats on the scale of mis-sales and their link to imperfections in product disclosure requirements, given the volume of the retail investment market (estimated to be around EUR 9 trillion in 2009), the impact of potential mis-sales would represent a very significant and material potential source of consumer detriment. Even if the Synovate figure of 60% was revised signficantly downwards, impacts are very material. This is compounded by the fact that detriment relates not only to losses borne – which typically drives perceptions of when a mis-sale has occurred, and only comes to the surface when risks crystalise – but also to opportunity costs and impacts through reduced competition and reduced market efficiency.

For these reasons, and given that effective product disclosure is a necessary (if not sufficient) condition for informed decision making, it is difficult not to conclude that failures in these disclosures are likely to have a substantial impact. Even if only 10% of sales in the retail investment market could be considered as 'unsuitable' this still amounts to almost 1 trillion EUR of potentially misheld products; to put this in context, even if product disclosure contributed only 1% to this, this would still amount to around 10 billion EUR (4 billion EUR for the non-UCITS part of the market). These figures need to be borne in mind when considering costs of changes.

Macro (aggregate) level

As noted, mis-sales or poor comparability of information can reduce competition and shopping around. This is clearest when considering poor comparability of products: a lack of readily comparable information by definition creates a barrier to comparing products. The UK FSA price transparency study noted above showed how improving cost transparency can lead to reduced costs overall. Price sensitivity on the part of a proportion of consumers can have benefits for the remainder of consumers. In addition, firms anticipate such sensitivity under conditions of greater price transparency (and also may independently compete more on price). Even small impacts on price can lead to a large overall benefit for consumers given the scale of business.

For instance, a 0.5% reduction of annual management costs might seem small, but in a market of EUR 9 trillion this would amount to EUR 45 billion benefits to investors, though of course lower costs would also equate to reduced surpluses for investment product manufacturers and distributors.This is in a context where research from Lipper demonstrates an EU fund market overburdened by small, relatively costly funds: in general they conclude (amongst other things) that a greater focus by investors on costs could drive important benefits.[56]

Industry side

An unlevel playing field between firms has the direct impact of varying costs of business, distorting competition. Regulatory arbitrage could encourage the development of products or sectors that are subject to the lowest levels of regulation, also undermining the effectiveness of regulation. While many stakeholders – including industry voices – have raised concerns relating to such effects it is very difficult to establish how far the design, commercialisation and marketing success of products is in practice determined by the nature of regulatory disclosure requirements, given the range of other commercial factors that can apply (such as tax regimes, culturally specific factors in particular national markets, internal firm strategies, and other regulatory requirements, such as authorisation, conduct of business or oversight requirements). However, as noted above, small steps on improving the salience of cost information, for instance, could have a large impact on consumer welfare in aggregate.

A number of industry stakeholders indicated in the recent consultation that a lack of standardisation and consistency across different sectors can raise compliance and administrative costs, especially for firms or groups operating across sectors or national markets.

Other more direct impacts of failings in regulation are also important. Mis-sales can also have a strong impact on firms, raising levels of compensation claims and complaints and internal costs related to managing these, and damaging brand identities. More generally, reduced retail trust of the investment markets could reduce liquidity and vital investment in economic growth and jobs.

3.4. How would the problem evolve without further action?

Irrespective of the Commission's commitment to make proposals for legislative changes in this area, it is possible to assess the counterfactual of no action at the European level. Under this scenario, problems would be likely to persist, and inconsistencies at the level of Community law would not be able to be addressed at any other level.

Some Member States have already indicated that they would take further action in the absence of an intervention at the EU level. This may have a beneficial impact with respect to investor protection and the level playing field within the Member States in question. However, it would also lead to further divergence of regulatory approaches across Member States, thereby potentially impeding market cross-border business and further complicating the legislative landscape, while, differences in regulatory approach cannot be addressed effectively at Member State level as they relate to differences in approach in Community law (for instance with highly standardised disclosures for UCITS, high level requirements only for insurance PRIPs, and a mixture of these for securities subject to the PD). Also, it is unlikely that all Member States would take unilateral action, leaving some markets without adequate regulation. Inconsistencies in approach between Member States would raise adminstrative and legal costs for firms operating in different Member States, and increase uncertainty for investors buying cross-border.

Some self-regulatory initiatives on the part of the industry can also be expected to emerge without further stimulus from the EU; evidence from the Call for Evidence and the Consultation indicates a certain willingness to take such steps, though it is difficult to assess the likelihood of such steps coming to fruition. In addition, self-regulatory steps are unlikely – as they would tend to continue to be sectorally discrete and vary between different Member States – to effectively achieve a consistent approach between sectors and across Member States.

At EU level, in the absence of new initiatives, existing workstreams would also contribute to mitigating the problems in certain sectors and for certain products. These include:

· Implementation of KII requirements for UCITS following adoption of new standard under UCITS IV;

· New implementing measures on summary prospectus and key information it must contain for the PD;

· Work on improving financial education, in conjunction with Member States; and

· Reviews of IMD and MiFID.

However, taking together these developments would not be able to address regulatory fragmentation and inconsistencies in approach between different sectors and different legislative initiatives, since these different initiatives and measures are designed to address a wide range of other regulatory challenges, other than the problems of comparability and comprehensibility of pre-contractual information addressed in this impact assessment. For this reason it is unlikely the comparability of different PRIPs would be improved; by definition tackling this would require a coordinated approach across product types. UCITS KII requirements would only apply to part of the PRIPs market, while measures on the summary prospectus are not likely to lead to documents that are directly comparable to the UCITS KII. Strengthened rules on distributors and those providing advice also would not in themselves improve the comparability of information about products, notably on costs or risks.

In fact, fragmentation and its consequences would likely worsen, following the introduction of prescriptive rules aimed at a short document for UCITS KII but no comparable rules elsewhere. As noted, the reactions of Member States to the introduction of these requirements are also likely to vary, raising additional coordination challenges. Even where all Member States seek to tackle level playing field issues between UCITS KII and disclosures for other products, it is probable that different Member States would develop their own alternative solutions to these challenges, thereby more deeply embedding fragmentation across the single market.

4. The EU's right to act and justification

Possible measures for addressing the problems identified in this impact assessment would be based on Article 114 of the TFEU. Given the identified problems, possible options for measures would necessarily relate to improving the conditions for the establishment and functioning of the internal market: establishing uniform conditions for the way investors in the Union are informed about investment products and how the information is provided to them, so as to harmonise operating conditions in relation to the information on investment products for all relevant players in the retail investment market, product manufacturers, persons selling and investors.

As set out in section 3.4, in the absence of such possible measures there would be a risk that obstacles to the functioning of the Single Market would emerge. Member States have already taken measures on the national level to address shortcomings in investor protection measures. It is likely that this development would continue in the absence of measures at the European level. Measures at the European level would counteract the development of divergent national approaches to investment information which would constitute an obstacle to the Single Market.

While there is increasingly cross border trade in retail investment products, divergent national approaches will also lead to different levels of investor protection, increased costs and uncertainties for product providers and distributors which represent an impediment to the further cross-border development of the retail investment market. Such further development would also require easy comparisons between products of different types across the Union. Divergent standards to investor disclosure make such comparisons very difficult and would therefore also create an obstacle to the further development of the Single Market for retail investment products.

Possible measures to address these obstacles to the Single Market would, if they were to be effective, need to apply for all relevant market players in the retail investment market. They would thereby contribute to improving the conditions for the establishment and the functioning of the Single Market in accordance with Article 114 TFEU.

According to the principle of subsidiarity laid down in Article 5(3) of the TFEU, action on the EU level should be taken only when the aims envisaged cannot be achieved sufficiently by Member States alone and can therefore, by reason of the scale or effects of the proposed action, be better achieved by the EU.

The problems to be addressed in this impact assessment relate to an unlevel playing field across the EU among different product manufacturers and persons selling investment products and consequent uneven levels of investor protection.

While some Member States have already acted on the national level, there are considerable differences in these national responses including Member States which have not yet undertaken any steps to improve retail investor disclosures. Responses are necessarily limited in their geographical scope and cannot be compared with or substitute a co-ordinated or systematic response on the EU level. Significant divergences exist and can, in the absence of action, be expected to continue to exist. Inconsistencies between Member States and across product sectors impede the growth of the single market, raise costs for firms operating across the Union, and reduce competition between product sectors and providers, whilst weakening the effectiveness of existing measures to aid investors in comparing between different investment propositions.

Achieving greater consistency in measures on transparency across Member States and product sectors is central to addressing the problems identified in this impact assessment. Yet such consistency cannot be achieved by action taken solely on the Member State level. Member States cannot create a Union wide level playing field for investment product manufacturers and persons selling and an even level of investor protection in relation to investor disclosures across the EU.

Therefore, action on the European level is needed.

In accordance with the principle of proportionality (Article 5(4) TEU), it is necessary and appropriate for the achievement of the objectives of this initiative to lay down principles relating to the content and form of the disclosure for retail investment products, as well as rules on drawing up and provision of these disclosures to retail investors. Such requirements should be further developed on level 2, so that a requisite level of consistency in measures can be achieved to facilitate comparisons between investment products originated in different industry sectors.

5. Objectives

5.1. General and specific objectives

The initiative seeks to improve the quality of investor decision making and the functioning of EU capital markets, tackling a breakdown in confidence and trust in the retail market. More concretely, it aims to:

· reduce levels of consumer detriment (mis-sales and mis-purchases of investment products); and

· create a more level regulatory playing field between competing products while tackling potential barriers to the single market.

5.2. Operational objectives

The operational objectives focus in on the steps needed to improve the quality of product disclosures. These steps can also tackle creating regulatory consistency, so as to achieve level playing field benefits and remove potential barriers to the single market.

· Improve comprehensibility of disclosures

· Improve comparability of products using disclosures

· Ensure disclosures are provided at the right time in sales processes

· Improve regulatory consistency

6. Options

6.1. Identification of options

Before assessing options, it is important to note that it is envisaged that any new measures to be proposed would follow a 'Lamfalussy' approach (see Annex I.10 for some further detail on this), with level 1 measures determining the objectives, broad approach, and outcomes being sought, and level 2 measures determining the detailed application of the level 1 framework to specific PRIPs.

This is consistent with the approach adopted for UCITS for the KII and in other areas of the financial services, and reflects the need for detailed technical measures (founded on expert technical advice) that may be readily adjusted in the face of market developments. On this basis, the questions to be addressed in this impact assessment relate not to the detailed content of proposed product disclosures (e.g. different options on the presentation of risk information, including through a risk rating and the underlying methodology for calculating it), but rather to the approach to be adopted in general to the product disclosures (e.g. the extent to which all PRIPs product disclosures should contain a risk rating).

As the problem description makes clear, product information impacts investment decision making in the context of specific sales processes with their attendent dynamics, whether the sale is an advised sale or a non-advised sale. It is difficult to isolate individual factors in assessing such dynamics. For much of the retail investment market, the actions of the sales person are crucial, by means of the recommendations they make, the products they may highlight or not even where a recommendation is not made, and the subtle ways in which they interact with the retail investor. Yet this should not be taken as relegating product disclosures to a purely ancilary role. Product disclosures have a wide range of both indirect and direct impacts on sales outcomes. This includes impacts on the behaviour of sales people (providing objective benchmarks that may impede uninhibited pushing of products), on the behaviour of product manufacturers (supporting greater competition on product costs and features), and, indeed, on the behaviour of retail investors (better assessing products). The problem description has already set out the relevance of improving product information as a means for addressing mis-sales in the retail market.

Given this wider context and the strong synergies between different factors in a typical sales process, it is important to underline that while this impact assessment relates solely to addressing the identified issues relating to information about products, other proposals by the Commission with supporting impact assessments, notably on the reviews of MiFID and the IMD, are underway separately, so as to ensure a coherent overall approach is taken to all the factors in sales processes that are amenable to regulatory intervention. The reviews of MiFID and the IMD address in particular measures on the provision of services of advice and the retail investor's understanding of these services and the management of conflicts of interest related to these services, so as to seek to align the interests of those selling products to retail investors with those investors. As noted, the PRIPs initiative was undertaken to assess the overall coherence and effectiveness of all measures regulating retail investment markets, and identified the key areas of product information and the regulation of sales as priority areas for intervenion. This IA delivers on the former of these two areas; the MiFID and IMD revisions on the latter.

The Communication on PRIPs already identified, on the basis of existing legislation and prior work, the broad areas that would need to be addressed by options for addressing the problems identified above:[57]

· the broad scope and purpose of requirements (i.e. focus on informing investors’ decision making, rather than, say, on providing contractual information);

· how information might be presented, including length of documents, or the kind or style of language to be used;

· the key areas of information to be included in documents, and the possibility of detailed measures (at level 2) for standardising the form and content of such information;

· who should prepare information and how to keep it up-to-date;

· steps for ensuring provision of information to the client (the medium to be used for information, and the timing of provision).

The policy options examined in this impact assessment build on this existing work, and have been grouped as follows:

(1) Scope of initiative. The precise scope of products that might be covered is key for ensuring all competing or comparable products are included, vital for addressing regulatory consistency objectives and comparability of information objectives.

Description of options

The scope of the regime is fundamentally bound up with its purpose: in improving comprehensibility and comparability of investment products, it is important to identify the products that can practically be compared with one another, otherwise measures to improve comparability could be misleading. Linked to this, the scope of the regime is central for considering possible regulatory arbitrage and level playing field impacts.

Previous work in the PRIPs initiative led to the development of a concept of ‘packaged’ investment products: under this issue we assess therefore whether this concept remains valid. Following consultation, the identified options are: (1) to set the scope wider than packaged products; (2) to maintain the focus on packaged products (see Annex I.3 for definition of these); (3) to combine (2) with a commitment to review and expand (or contract) the scope if necessary.

(2) Degree and nature of standardisation of product disclosures. Standardisation relates both to the degree of prescription imposed on firms in regards the content and format of disclosures provided to retail customers, and to the degree of consistency in requirements between products and financial sectors. This area is central for determining the overall approach to be developed, and is key to driving costs and benefits.

Description of options

The objectives of achieving regulatory consistency, improving comprehensibility and improving comparability of documents are linked directly to the extent of consistency of approach across different products, and the degree to which this consistency is used to achieve standardisation of the content and format of documents. Increased standardisation is (generally speaking) likely to increase benefits for investors but may increase costs for industry. (Standardisation may also reduce legal risk reducing some costs for industry).

The many possible detailed options on content and form can be broken down according to the areas identified in the problem definition relating to comprehensibility and comparability (language and length of disclosures impeding comprehensibility, and different presentations of product features, risks and costs impeding comparability). In each area, the specific options explored (outlined in table 3 below) broadly sit on a spectrum between greater and lesser degrees of prescription and standardisation.

(3) Responsibilities for preparation. Stakeholders and consultation respondents have broadly underlined the importance of clarity over who is responsible for preparing (and updating) disclosures.

Description of options

When assessing responsibilities for preparation, options range according to the degree of prescription applied in regards who should prepare the information. The identified options are: (1) not specifying who should be responsible, but leaving this to market participants to decide; (2) not prescribing responsibilities, but requiring agreements between market participants over responsibilities; (3) placing a general responsibility on the product manufacturer, but allowing for some targeted exceptions; and (4) [not mutually exclusive with other three options] requiring disclosures of responsible parties and product manufacturer in document.

(4) Timely provision. Ensuring effective and timely provision of product disclosures to retail investors is vital if disclosures are to be used.

Description of options

Different models for disclosure provision can be found across existing product disclosure measures, broadly ranging from (1) a ‘soft’ requirement whereby product disclosures are prepared by manufacturers and provided to distributors, but distributors are not required to use these for discharging their responsibilities, to (2) a ‘hard’ requirement whereby product disclosures prepared by the manufacturers must be given by distributors to the investor (as is now the case with UCITS). Given the variety of distribution channels across PRIPs, an additional option (3) can be identified where some flexibility is introduced as to the what counts as ‘providing,’ to ensure practicality requirements for all channels.

(5) Flanking measures: civil liability and sanctions. How should civil liabilities associated to the document be clarified, and are there steps to be taken on further harmonising the use of sanctions by competent authorities when supervising the regime?

Description of options

The UCITS KIID regime, as with the PD disclosure regime, contains specific measures to clarify the liabilities associated with the KIID, designed to ensure the document is practically treated as a pre-contractual communication document by product manufactures – the simplified prospectus had earlier become bloated through the inclusion of too much fine print. The UCITS KIID regime and other measures in the area of the Financial Sercices also take or are proposing to take steps on better coordinating the sanctions that apply at the national level following breaches of measures. Options for addressing these areas for PRIPs include: (0) remaining silent on liabilities / sanctions (baseline); (1) use of non-legislative techniques to ensure access to and use of redress; (2) clarifying liability regime attached to PRIPs product disclosures; (3) approaching sanctions in a high-level way; and (4) taking steps to harmonise aspects of sanctions.

Table 3: Summary of options

Issue || Objectives addressed || Policy options

1 Scope (products for which disclosure requirements should be aligned and improved) || All || 0 – Take no action 1 – Set the widest possible scope 2 – Only 'packaged' products 3 – Only 'packaged' products, but set firm review date [Options are mutually exclusive]

2 Degree of standardisation · || a || Plain language, engaging quality of document || Comprehensibility || 0 – Take no action 1 – Apply high-level principles only 2 – Prescriptive rules to standardise elements of language, ‘look and feel’ of document 3 – Use of non-legislative tools 4 – Clarify liability attached to document [Options 1 and 2 are mutually exclusive; option 4 also addressed under issue 5]

b || Length of document || Comprehensibility || 0 – Take no action 1 – Set a ‘soft’ limit on length; prescribe contents and length where viable at level 2 2 – Set a ‘hard’ limit on the length of all documents (e.g. 2 pages A4) 3 – Use layering of information / signposting to other documents [Option 3 is not mutually excusive with 1 and 2]

c || Accuracy, balance of information || Comprehensibility || 0 – Take no action 1 – Set high-level principles only 2 – Use prescriptive requirements on form and contents to ensure balanced presentation [Options are mutually exclusive]

d || Comparisons of product features, risks, costs || Comparability || 0 – Take no action 1 – Seek consistent structure, layout to aid comparisons 2– Standardised risk, cost, and performance disclosures for all PRIPs [Options are not mutually exclusive]

3 Responsibility for preparing product disclosures || All || 0 – Take no action 1 -- Flexibility over who prepares the document 2 -- Flexibility over who prepares the document, but requiring agreement on responsibility 3 -- Product manufacturer normally responsible for preparing the document 4 – Require disclosures of responsible parties in document [Options 1 - 3 are mutually exclusive; 4 is not mutually exclusive with 1 - 3] ||

4 Requirements on delivery of product disclosure || Ensuring provision || 0 – Take no action 1 – ‘Soft’ requirement on provision and its timing 2 – ‘Hard’ requirement on provision and its timing 3 – Broadly follow 2, but allow for some targeted exceptions [Options are mutually exclusive] ||

5 Flanking measures: civil liabilities and sanctions || All || 0 – Take no action 1 – Non-legislative steps to ensure access to redress 2 – Clarifying liability attached to document 3 – Clarify sanctions in high level manner 4 – Clarify sanctions in more detail [Option 3 is mutually exclusive with 4] ||

6.2. Analysis and comparison of options

For a full discussion of each issue, the identified options, and assessment of the costs and benefits of the different options, please see the relevant section in Annex II.

6.2.1. Issue 1 – What scope of products should be covered?

Defining which products are 'competing' for retail investments has been hotly debated throughout the PRIPs work. The Commission proposed in its Communication a focus on 'packaged' investments. Stakeholders have generally recognised the practical validity of the concept of packaging, and that packaged investments share features amongst themselves (and differ in important ways from non-packaged investments), and likely need stronger consumer protection measures, including steps to enhance comparability. Some take the view that the scope of the initiative should nonetheless be as broad as possible.

Box 3: Defining Packaged Products

The Commission consultation on PRIPs has steadily refined a possible definition of retail investment products of the packaged form. At its core, the definition refers to the investor's exposure to uncertainties in outcomes, and the intervention of financial engineering in this regard:

A PRIPs is any investment where the amount repayable to the investor is exposed to fluctuations in the performance of one or more assets or reference values, and where the investor does not directly purchase or sell these assets.

Products solely linked to interest rates or where outcomes are wholly guaranteed and known beforehand would be excluded, as would financial products that are pure insurance products (general insurance products, or pure protection insurance products).

Many stakeholders have views (positively or negatively) on the precise application of the concept of packaged products to particular products, e.g. as may exist in particular national markets.

Option || Effectiveness || Efficiency

Comprehension || Comparison || Regulatory Patchwork

0 – Take no action || 0 || 0 || 0 || 0

1 -- Set the widest possible scope || + Effective approach would still require boundary to be drawn between 'packaged' and 'non-packaged' products; wider scope could allow for overall better coherence. || + Effective approach would still require boundary to be drawn between 'packaged' and 'non-packaged' products; wider scope could allow for overall better coherence. || + Existing unlevel playing field is practically focused on 'packaged' products, but wider focus || Depending on approach, costs for industry may be comparable to focus on packaged regime, but marginally greater due to wider impact. Benefits for consumers depend on extent to which regime still segments between packaged and non-packaged products; effectively challenge of demarcation of products cannot be avoided.

2 -- Focus on 'packaged' products || + Key benefits relate to packaged products, so only likely to be marginally less effective than 1. (May be more effective in practice due to more focused approach.) || + Key benefits relate to packaged products, so only likely to be marginally less effective than 1. (May be more effective in practice due to more focused approach.) || + Existing unlevel playing field is practically focused on 'packaged' products || Costs likely to be lower than for 1, as impact targeted on those products that are most relevant, and option 2.1 would likely still need to demarcate in measures between packaged and non-packaged investments. Core benefits achieved in relation to packaged products, so likely to be equivalent to option 2.1

3 -- Focus on 'packaged' products, but set firm review date (e.g. five years following coming into force) || ++ Key benefits relate to packaged products, so only likely to be marginally less effective than 1. (May be more effective in practice due to more focused approach.) Review of scope allows possible future arbitrage and consumer detriment to be addressed || ++ Key benefits relate to packaged products, so only likely to be marginally less effective than 1. (May be more effective in practice due to more focused approach.) Review of scope allows possible future arbitrage and consumer detriment to be addressed || ++ Existing unlevel playing field is practically focused on 'packaged' products Review of scope allows possible future arbitrage and unlevel playing field issues to be addressed || Costs likely to be lower than for 1, as impact targeted on those products that are most relevant, and option 1 would likely still need to demarcate in measures between packaged and non-packaged investments. Core benefits achieved in relation to packaged products, so likely to be equivalent to option 1. Review mechanisms allows for possible regulatory arbitrage, countering possible weakness with option 2

As the table makes clear, all approaches to scope have their merits and their problems.

Costs are likely to be similar for the bulk of the market across all options, though the precise form and cost/benefit impact of the first option is difficult to assess (it could be developed in a manner which was extremely impactful or without major impact, depending on the choices made for other options below, e.g. the degree of standardisation chosen).

However any distinction between packaged and non-packaged investments is subject to changes due to innovation. Experience has shown that wherever the boundary is drawn, the risk remains that investment propositions might be developed which are economically similar or the same as those captured by the defined scope but which fall nevertheless outside defined boundaries or sit at least at the edges of that scope. The determination of a boundary may well thereby encourage or facilitate regulatory arbitrage, contributing to further complexity in the market. This is of course without prejudice to providing the necessary legal certainty on scope (which can be achieved in a variety of ways at level one, supported as necessary through detailed implementing measures).

Nonetheless, the case for maintaining an initial focus on packaged investments is also strong, and seems more proportionate than a wider scope, as it focuses action on the products that are likely to deliver the main benefits from better disclosure regimes, without overly diluting the regulatory design process in order to address marginal cases. These are mostly directly comparable products, where a common product disclosure regime can be readily envisaged.

Given the broad issues that might arise in regards arbitrage, the option of a two step approach is strongest: to focus for now on ‘packaged’ products, being as these are financial products that are manufactured for the purposes of providing investments to retail customers, but to reassess whether a wider scope might be appropriate at a predetermined point in the near future. The scope of products that would be caught by this approach and a possible way of defining them more in detail e.g. with respect to the future legal instrument on disclosure is presented in Annex I.3.

Box 4: Pensions: a special case?

Given ongoing work following the Green Paper (see Annex I.2) it may be premature to determine the appropriate EU dimension of rules on disclosure for these, particularly as regards Pillar II pensions, but some respondents to the consultation strongly argued that products that might be determined as pensions, particularly under Pillar III , were directly, in their view, substitutable for other PRIPs in some markets. In addition, it can be argued that decision making in relation to pension and retirement planning raise additional consumer protection issues compared to other PRIPs that warrant even stronger consumer protection measures tailored to national pension systems, but at least subject to similar standards of disclosure as other investments. Issues include, for instance, achieving clarity on possible restrictions on how pension investments might be used, on the specifics of individual tax treatments, and on the typically long term nature of the investment and the need to assess the likely income that the pension might deliver in the future, which makes the calculation or assessment of possible future benefits, such as retirment income backed by an annuity, more complex and difficult to explain than for ordinary investments, and also raises additional specific factors such as the impact of changes to longevity. Certainly, therefore, there are additional information requirements that should apply for investments used as pensions compared to other investments.

6.2.2. Issue 2 – How far and in what ways should disclosures be standardised at EU level?

As it has been mentioned above, the UCITS KII regime is highly prescriptive and strongly standardises the "look and feel" and contents of UCITS KIIDs, so as to promote comparability of information and comprehension. This approach also has benefits relating to regulatory consistency (potentially reducing costs for firms, given the cross-border nature of the UCITS market, and the role of the KIID within notification procedures for marketing cross-border).

Given that here we address other products, which are prepared and offered by different manufacturers and distributors, we should now examine how far (and in what ways) such a standardised approach might be applied more widely. This issue relates also to specific policy options for improving comprehensibility and comparability of product disclosures.

Comprehensibility

Improving use of plain language and making information more engaging

Option || Effectiveness || Efficiency

0 – Take no action || 0 || 0

1 – Apply high-level principles only || – Experience with UCITS simplified prospectus showed that high-level requirements were not sufficiently effective in ensuring comprehensible information in documents. Ensuring firms, supervisors approach standards in consistent way would be difficult to achieve, leading to inconsistencies in outcomes. || Effective engagement by supervisors with firms could be costly / inconsistent, given lack of guidance in a high-level approach. Some lack of legal clarity for firms as to necessary standards; inconsistencies cross-border would erect barriers to single market. Flexibility may be valuable for allowing innovation in terms of communication practices.

2 – Increased prescription || + + Experience with developing UCITS KII requirements is that higher standardisation allows for setting better 'minimum standard' for all, so that best practices can be more immediately reflected into generalised industry practice. Greater consistency in approach across all markets / sectors. || Consistency and better clarity could lead to reduced costs for firms and supervisors. Benefits for investors through wider adoption of better practices enshrined in binding EU level requirements. May be seen as a 'tick-box' approach by firms, or a regulatory 'safe harbour' if they follow the letter but not the spirit of the rules.

3 – Use of non-legislative tools || ++ Can support 2, e.g. national regulators, firm trade bodies, consumer associations may be best placed to develop practical guidelines on better language, common glossaries, will better address continued scope for poor language. || Costs expected for developing and improve industry practices, but benefits for consumers from better addressing possible weaknesses Allows flexibility for allowing innovation in terms of communication practices Can overcome tick-box approach possible under 2 on its own

4 – Clarify liability attached to document || + UCITS experience was that success (shortness, clarity of language) of document requires some comfort for firms that they may focus only on 'key' information and not include all possibly relevant information. || Lack of clarity could undermine document, as firms' concerns over liability lead to inclusion of all possibly relevant information, rather than sole focus on key information.

As our problem definition outlined, typically firms have approached product disclosures in a legalistic manner (minimizing legal risk of breach by flood of information), rather than as an opportunity to communicate effectively with potential clients in a plain manner. For the UCITS KIID therefore measures were adopted to ensure the disclosure was approached as a ‘communication’ document, including a clarification of legal liability and relatively strong prescription of the form and content of the document. However, some stakeholders (both industry and consumer representatives) have commented that such an approach needs careful support, e.g. through the development of common glossaries of terms, sharing of best practice, and careful supervision by competent authorities. This option appears most proportionate, as it would better guarantee benefits, at relatively low additional costs for developing such support.

Clearly, any intervention into the current practice of disclosures will have a significant adjustment cost impact on industry compared to the baseline. Acting on the language of the disclosure alone, would trigger approximately the same magnitude of costs as action on all components of the problem driver together (i.e. language, information overload, accuracy and balance, comparability). On the other hand, benefits to consumers would increase with each additional field of action. Therefore, in this impact analysis, we decided to carry out the final cost benefit analysis of all components together as a package (under section 6.3) and explain - mainly qualitatively - marginal costs and benefits under each section.

As for marginal costs: while high level standards (1) may leave some more scope to current disclosure practices, and would therefore have lower cost impacts, it would not address the problems identified as effectively as options 2 and 3. The consumer benefits expected from more prescriptive and standardised rules will clearly be highest, while some industry benefits are also expected from this option in terms of more level playing field and less legal fragmentation to market access. Under either approach, the magnitude of costs will still greatly depend on the technical implementation at Level 2.

(Liability is analysed separately under issue 5 below).

Addressing information overload

This analysis considers the specific issue of overly complex and long documents.

Option || Effectiveness || Efficiency

0 –Take no action || 0 || 0

1 – Set a soft limit on length: prescribe contents and length where viable at level 2 || + In practice may be similar (due to impact of prescription on content) to option 1, but flexibility may allow for better tailoring of requirements to specificities of non-harmonised products. || Varied requirements lead to inconsistencies in approach between supervisors and firms.

2 – Set a hard limit on the length (and content) of all documents (e.g. 2 pages A4) || +/- For UCITS a hard limit on the document could be readily considered because UCITS are harmonised across the EU. With other PRIPs which are not harmonised, the product features or benefits may not be always covered in 2 pages (even for UCITS this is not always possible; structured UCITS are provided with a derogation from the 2 page limit). Given this, enforcing a 2 page limit could lead to documents that do not cover all information clearly or comprehensibly. Setting a hard limit may be an effective tool for ensuring firms write in a concise manner: evidence suggests longer documents may not be read. || Simple requirement straightforward for competent authorities to supervise: consistency in approach.

3 – Use layering of information / signposting to other documents || + Layering may be useful for targeting key information and more detailed information appropriately. Layering might undermine extent to which KIID must is capable of being used 'stand alone' (i.e. on its own) to make an investment decision – ensuring this does not happen raises risks for supervisors || Use of 'layering' or 'signposting' may require more careful supervision and assessments of compliance raising some costs,, however may allow same documents to better target range of different investors needs.

The length of disclosures – as set out in the problem definition – has long been considered a major impediment to their effective use by retail investors. On this basis, the UCITS KIID requirements set a hard limit on document length (though with a derogation for structured funds). While theoretically a hard limit would deliver the greatest consumer benefits, it is difficult to apply this approach to non-harmonised products in practice. Therefore the preferred option is a soft limit.

An additional technique to soft limits that may serve to address length problems is the use of ‘layering’ or signposting, raised by both consumer and industry stakeholders. Such a technique can allow different investors with different degrees of financial literacy to be served by the same document – those requiring further information can be directed effectively to find it. It is vital however that cross-references are not used to fragment access to key information, which would undermine the effectiveness of the whole regime for investors. In all cases, that is, the KIID should be able to function on a standalone basis, as relying on other documents for key information would defeat the overall purpose of the KIID).

In terms of marginal costs, a soft limit with specific requirements tailored for particular PRIPs at level 2 might not be significantly different in impact to a hard limit at level 1.

Ensuring accuracy and balance of information

This analysis focuses on the problem of accuracy and balance in information in product disclosures.

Option || Effectiveness || Efficiency

0 -- Take no action || 0 || Issues identified in problem definition would continue, as set out in 3.4.

1 – set high-level principles only || - While in general the principle of being 'not misleading' covers such issues as a lack of balance in information or inaccuracy in information, without more detailed requirements inconsistencies between firms and between Member States would emerge, reducing comprehensibility of information for customers It is likely, given difficulties in enforcing principles, that presentation of information could be 'gamed' (enabling subtle investor biases to be exploited) || Could raise supervisory costs, given potential subjectivity of standards Inconsistencies in approach between supervisors or lack of legal certainty might raise compliance costs for some firms, and negatively impact consumer benefits

2 – use prescriptive requirements on form and contents to ensure balanced presentation || + Reduced misunderstandings by investors: YouGov and IFF testing of KII proposals for UCITS suggested that precise positioning of information (e.g. putting cost information on front page, performance on back page) can be material in impacting consumer comprehension of relative importance of messages; specifying these in prescriptive rules could lead to higher minimum standards across all PRIPs || Consistency in approach could reduce some supervisory costs Legal certainty for firms

Accuracy and balance are generally applicable high-level principles across the financial services in regards communications between firms and potential investors. However, subtle juxtapositions and hierarchies of information (for instance, placing cost information on a back page) can have strong impacts as to how salient information is taken to be for retail investors. On this basis, the UCITS KII was designed carefully to prescribe a specific order to information. Given the risk of subtle biases in information, the use of prescription for other PRIPs is the preferred option; some consumer stakeholders have specifically underlined this point. In terms of marginal costs, this would likely reduce costs over a more flexible approach for both supervisors, and to a degree, firms.

Comparability

This analysis focuses on the central objective of enhancing comparability between products, and assesses the effectiveness and efficiency of standardisation / prescription in this regard, along two axes: (A) the 'layout' of the documents (order of information and labelling of information in the document), and (B) the specific area of potentially quantitative or objective information that can be used for comparisons (on product risks, costs, and performance).

|| Option || Effectiveness || Efficiency

A LAYOUT || 0 -- Take no action || 0 || 0

1 – Prescribe consistent document structure to aid comparisons || + Consistency in structure will benefit investors in comparing between products, potentially improving comprehension and confidence in using information. Consistency in structure may run the risk of taking a ‘one-size-fits-all’ approach that reduces effective communication of specific features of some products – care must be taken to test approach to ensure effectiveness for consumers. || Consistency may redu