What’s in a name?
In May, the European Commission unveiled its Retail Investment Strategy (RIS), the latest iteration of regulators' attempts to encourage public participation in the private markets. As part of the policy, an omnibus directive was introduced that will make amendments to the AIFMD and MiFID.
Ajay Pathak, partner and co-chair of Goodwin’s London office, singles out the main elements of interest for GPs: “The three key points of the RIS for fund managers are the avoidance of undue costs, the broadening of the definition of what constitutes a ‘professional investor’, and a ban on inducements.”
The Commission’s proposal on undue costs is a legislative answer to ESMA’s regulatory call of concern about diverging levels of investor protection. As a result, the legislator is looking to establish a ‘value for money’ test as already implemented in MiFID and the Insurance Distribution Directive.
To be developed by ESMA and the European Insurance and Occupational Pensions Authority, it should allow investors to benchmark costs, likely through standardised reporting on products and requirements around reasonableness and proportionality of costs.
This proposed change would affect funds and distributors marketing exclusively to professional investors as well.
Retail the professional
As part of the proposal, the Commission is looking to broaden the scope of the definition of ‘professional investor’, an approach Pathak welcomes: “It demonstrates pragmatism. Marketing rules for professional investors are quite restrictive at the moment and often not reflective of these individuals’ financial literacy.”
Proposed measures include lowering the investment threshold from €500,000 to €250,000 and an extension of the eligibility criteria to capital markets experience, as well as the recognition of professional training.
Some market participants however, do not deem this enough. In its response to the Commission’s call for evidence, Titanbay proposed the adoption of a ‘semi-professional’ category across the AIFMD and MiFID as this “is already available in local regulations across approximately half of EU countries, and it allows for a broader group of experienced investors to access private markets”.
But the market has not reached a consensus, as the Association of the Luxembourg Fund Industry said a definition of ‘semi-professional investor’ “would lead to a large number of changes to the entire MiFID framework” and “significant implementation costs for the financial industry”.
Similar approaches to Titanbay’s proposal exist in Germany and Italy, where retail investors need to demonstrate a ‘general understanding’ of the risks involved in private markets investments.
Other responses try to strike a balance between the two extremes. Invest Europe called for a “professional upon request” classification to further broaden the scope of eligible investors.
Further growing the pool of eligible investors is a positive development, as this is likely to increase the amount of capital available and address concerns around the nomenclature of ‘retail investment’ in the context of the private markets.
A widely discussed third amendment is a proposed ban on inducements. “In my opinion, this is simply a measure to do away with hidden charges and conflicts of interest,” says Pathak. “It broadens the limitations on non-advisers, such as distributors, and applies similar rules to those that currently apply to investment advisory firms.”
Recently removed through the ‘MiFID Quick Fix’, marketing participants have pushed back on the proposed measure. Responding to the Commission’s call for evidence, AMUNDI called it “detrimental to the access to products and advice for retail investors”, stating that “inducements play a key role in ruminating the cost of advice”.
ICI Group proposed to “limit inducements where appropriate, considering local distribution systems and the maturity of the market”, and “requiring distribution-related fees to be in the best interest of investors”.
The proposed amendments to the AIFMD make it clear that investor protection is at the forefront of the European Commission’s agenda for its retail investment strategy. In principle, measures to reduce any undue costs charged from either the fund manager or a distributor are a positive development and – as Pathak points out – not an entirely new idea.
Further opening up the criteria for who is eligible to invest comes with its positive effects, but with the regulator’s duty to protect the investor – and arguably rightfully so, as while a reliable and stable asset class, GPs themselves acknowledge it to be a high-risk high-reward market – it is walking a fine line of balance.