The EU’s proposal will require that retail investors are shown a synthetic information document before purchasing so-called packaged investment products. Packaged investment products – a €9 trillion market - include investment funds, insurance products linked to financial markets and structured retail investment products. The purpose of the proposal is to make information on investment products more intelligible and comparable for retail investors.
Finance Watch’s position paper calls on the EU to be more ambitious in its proposal. In addition to measures for a Key Information Document, it should also adapt the UCITS investment rules to prevent retail investors from being offered products that are not suitable for them. It should also give more information about the costs and impacts of structured products.
The paper’s author, Frédéric Hache, said: “Clear, comparable information is essential to protect retail investors and we therefore welcome the Commission’s proposal. There is, however, some evidence that intervening only at the point of sale may not be enough to protect investors. With complex investment products, this is especially worrying.”
Thierry Philipponnat, Secretary General of Finance Watch, said: ““Investment products have social as well as financial consequences. If society wants capital to fund productive activity, the first step is to let investors know whether they are making an investment in the economy or a financial bet.”
Finance Watch's main conclusions on the proposal are as follows:
The new Key Information Document might have a detrimental impact on other socially useful investments outside the scope. To the extent that packaged products will be perceived as less complicated, they might attract previously reluctant investors hoping for excess return in a context of low interest rates. An unintended consequence might be to implicitly promote packaged products to the detriment of other socially useful investments that contribute to growth, employment, or the stable funding of loans, such as direct holdings of shares, bonds and bank deposits.
Recommendation 1: Widen the scope of this regulation and further specify some terms in Article 2’s exclusion list
Improving disclosure alone will not be enough to protect retail investors. Improving information transparency is good but research shows that it will be not sufficient to enable retail investors to make suitable investment decisions because:
a. retail investors exhibit a low level of financial literacy;
b. many financial advisors do not understand all the risks involved in the products that they sell, while empirical evidence shows that retail investors rely heavily on advice;
c. behavioural economics shows that investors suffer from biases in their decision making and their financial capability is more influenced by psychological than informational factors;
d. there is a huge difference between understanding how a financial product works and being able to assess the risks attached.
Existing Directive on UCITS investment funds includes product rules that should be adapted to all packaged products. The new Key Information Document is adapted from the UCITS directive on investment funds. This directive also includes investment rules that limit eligible assets, use of derivative instruments etc. to ensure the suitability of investment products offered to investors. These rules are an essential element of the soundness and success of UCITS and are all the more necessary in the wider context of packaged investment products. They should therefore be adapted and used in this area as well.
Recommendation 2: Introduce product design rules adapted from UCITS to further protect investors and ensure the suitability of investment decisions.
There is a political and societal dimension to retail savings. The size of the EU packaged retail investment market is colossal at close to €9 trillion in 2009. In a context of strained public finances and the need for well-capitalised EU financial institutions and well-funded EU corporations, we need to think of where we want to incentivize retail savings. Some investments are socially useful as they not only offer good potential returns but also contribute to financing the real economy or supporting GDP and job creation in the European Union. Others are just bets with no economic value.
Recommendation 3: Introduce a social usefulness dimension through disclosing amongst the ESG (environmental, social and corporate governance) objectives whether the financial product is an investment or a bet, and through excluding from eligible assets those with demonstrated adverse societal consequences.
Finding a comprehensive methodology to summarise all risks in a single indicator is unlikely. The European Commission proposes to introduce a summary risk indicator that would give a risk grade to investment products. However finding a robust common methodology for all packaged products appears difficult. A summary indicator including only some of the risks could be more misleading than useful.
A risk indicator in a grade format may have a detrimental psychological impact, as investors are likely to focus unduly on it and pay less attention to the accompanying narrative explanation of other risks. Such an indicator might also give an illusion of simplicity and comparability, whereas it would not provide for better understanding but instead rely on a methodology that investors do not understand.
The crisis has shown that the overreliance on external risk indicators in a grade format such as ratings was not desirable. Introducing a new indicator of a similar format might not be consistent with the objective of reducing overreliance on external ratings in EU regulation.
Recommendations 4 and 5: Remove the summary risk indicator and replace it by a multifactor scenario analysis.
The multitude of ESG principles and norms creates a risk of “greenwashing” and box-ticking. The text proposes to disclose the environmental, social and corporate governance (ESG) objectives of the investment products. It does not, however, specify the criteria or the principles to be used. As there is a vast number of socially responsible standards of varying strictness and no internationally agreed framework, failure to propose sound standards might lead to “greenwashing”.
Fees are only the visible part of the costs of structured products: other costs are embedded during the structuring phase of the product. These costs are not paid upfront but financed through additional risk taking by investors. As they reduce investors’ potential returns on their investment we believe that they should be disclosed in a transparent manner.
Recommendation 6: Request the disclosure of the theoretical margin at maturity of structured products.
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