Over the last few years, the financial services regulatory landscape has become a congested place: Solvency II, FRTB, CVA, MiFID II, EMIR, PRIIPs, to name but a few. While each regulation targets a specific financial body, they can all be said to aim toward creating safer and more robust financial markets. It is important, therefore, to look at any overlaps that occur between regulations: starting with MiFID II and PRIIPs.
In 1999, the EU laid down the Financial Services Action Plan (FSAP), seeking to break down barriers between European nations and, in turn, complement the introduction of the Euro. The Markets in Financial Instruments Directive, known as MiFID, was the centrepiece of this action plan, and in 2007 MiFID I was introduced, focused on bringing fundamental changes to securities trading and encouraging competition across financial markets.
Time, however, has educated regulators on how the spread of new trading venues has complicated trading processes, leading to increased trading activities from outside regulatory jurisdiction. It has consequently become evident that, without consistent rules, transparency will suffer – a fundamental pillar of operations in open and fair markets.
MiFID II was introduced in 2014, particularly to address transparency and how it must be maintained to protect the long term security of the market, including covering a larger set of financial instruments. New rules known as RTS – Regulatory Technical Standards – are also set out for data publication and access, reporting obligations, and best execution.
With financial market complexity regarding the type of execution or publication venue (RM, MTF, OTF, APA and SI) and types of financial instrument increasing, the RTS have been developed in great detail. Transparency, in particular, is required across a far broader range of elements, dependent on the trading settings. Pre-trade transparency requirements differ from post-trade transparency; and the kind of transparency needed in shares, depositary receipts, ETFs or certificates is different from that required in bonds, structured finance products, or emission allowances derivatives (RTS 1-2).
Alongside MiFID II, a regulation on Key Information Documents – KIDs – for Packaged Retail and Insurance-based Investment Products – PRIIPs – has been developed. This has arrived as a response to the increased complexity of financial products that lack focus on EU retail investors’ needs. With PRIIPs, the European Commission intends to protect EU retail investors by providing them the capability to compare or match a number of key features: 1-7 scale risk-reward profile, summary risk indicators (liquidity risk, credit risk, market risk, counterparty risk, operational risk), description and composition of applicable costs of investment funds across a wide part of the market in order to support their investment decisions in a more effective way.
KIDs apply to packaged products that are “subject to fluctuation because of exposure to reference values, or subject to the performance of one or more assets which are not directly purchased by the retail investor”. Examples would be structured products, insurance-based products, investment funds, and pension funds.
The list of MiFID II financial instruments is extended and currently covers: shares, depositary receipts, exchange-traded funds, certificates, bonds, structured finance products, emission allowances, derivatives and many more complex instruments. It is not surprising that the principles of PRIIPs reveal commonalities with MiFID II: both regulations address complementary transparency rules to the same investment packaged products, and are both developed by the same regulator, The European Commission in association with ESMA – The European Securities and Markets Authority.
Definitions – what’s in the detail?
While MiFID II sets out policies for all financial instruments, PRIIPs specifies rules for a subset – packaged complex financial instruments. And as the list of PRIIPs is still subject to further clarification from the EC due to the speed of innovation and development of these products (and the unclear conceptual definition of “reference value” as mentioned above), one can still base a certain confidence on a number of asset classes that suit the properties carried by MiFID II, such as derivatives and structured deposits.
Structured deposits are defined for PRIIPs in point (43) of Article 4(1) of Directive 2014/65/EU. Accordingly, a KID needs to be created for these retail product types. ‘Retail Investors’ are defined similarly to ‘Retail Clients’, as defined in point (11) of Article 4(1) of Directive 2014/56/EU or a customer within the meaning of Directive 2002/92/EC, where that customer would not qualify as a professional client as defined in point (10) of Article 4(1) of Directive 2014/65/EU.
In a broad sense, market participants are required to provide high quality information related to the financial instruments they are trading in. Whether it is for the purpose of pre- or post-trade transparency or for KID’s key feature assessments, a number of mandatory attributes are necessary to generate the required MiFID II reports as well as to compute the risk-reward profile and associated costs to PRIIPs. The KID is required to act as a “fair, clear and not misleading” standardised document. MiFID II adds and expands these properties to all financial instrument types.
To be more specific, the section titled “What is this product?” seeks essentials (regardless of the nature of information displayed – descriptive or classificatory) such as the type of PRIIP (the legal form of the product), objectives (listing the main factors upon which the product return depends, underlying assets, how return is calculated, etc.) alongside other information such as maturity date of the PRIIP, and expiration date if applicable.
Similarly, MiFID II calls for requirements that might be termed differently, such as the type, risk, currency, volume of financial instruments, flags for pre/ post-trade transparency and many more. MiFID II applies even further rules by setting thresholds to attributes such the average daily number of trades for structured financial products and average daily notional amount of transactions executed. It makes sense then to consider assessing PRIIPs and designing their respective KIDs in a way that complies with such MiFID II disclosure requirements as well.
In another section titled “What are the risks and what could I get in return?” it is required to supply the so-called Risk-Reward Profile determined by the Summary Risk Indicator (SRI). The SRI is represented by a scale from 1 to 7, with 1 being the lowest and 7 the highest risk product. The SRI is assessed based on the market, currency and credit risk. Attributes like price volatility, and VaR-like formulations are required to materialise this Risk-Reward Profile. Firms under MiFID II on the other hand are required to generate their own models – subject to justification – to assess the risk of their products. With retail investors being required to comply with both MiFID II and PRIIPS, they can benefit from applying the same risk assessment approach for these products.
Overall overlap – and separation
and it is the product manufacturers (i.e. investment banks) that need to put an automated architecture in place that complies with both the reporting standards of MiFID II from one end, and the KID generation requirements from the other end, for optimum cost and time efficiency.
The European Commission recently announced a one-year extension to the application date of KIDs for PRIIPs, to 1st January 2018, which brings it closely aligned with the corresponding date for MiFID II (3rd January 2018). Accordingly, ESA, EBA, ESMA and EIOPA have received a set of amended draft RTS focused on multi-option PRIIPs, performance scenarios, comprehension alerts and presentation of the insurance related costs – concerns all raised by the European Parliament.
The ESA is given a period of 6 weeks to review these changes and submit their opinion back to the European Commission for adoption, and in turn, to the European Parliament and the Council for examination. Subsequently, on 22nd December 2016, EIOPA, EBA and ESMA responded to the European Commission that “the three ESAs are not in a position to provide an agreed opinion on the amended draft RTS”.
Changing regulatory standards over time
In light of the delays to both regulations, market participants are given more time to rethink their implementation strategies properly and, ideally, to think of redesigning the whole system towards a more generally compliant nature that not only conforms with immediate needs but also with a view to the future, assisting proper data collection and leveraging adequate standards. It is also worth mentioning that such a redesign is equally important for the regulators as well to have the ability to quickly and easily assess and understand the data associated with financial instruments.
Much is made in modern times of ‘increasing demands’ on financial services firms, but with regard to regulatory compliance, this is very much the case, with some overlapping and others diverging. Firms that are required to comply with many principles simultaneously must aim to unify their views on data across all business divisions and financial instrument types. The advantages of deploying an IT system therefore, for equal levels of control, robustness and flexibility, with the ability to consolidate at the highest quality and slice and dice data transparently, are as far-reaching as they are desirable.
The technology exists to achieve this, and by way of best practice, naming conventions, and established well-defined and extendable data models organisations can be set up to deal with the avalanche of regulations over the next few years effectively. Within this, the cost and complexity of managing, validating and distributing data – of every type – can be reduced significantly.
The rise of fintech and regtech provides prosperous ground for the industry to move away from siloed structures toward holistic data management systems for acquiring, normalising, consolidating and validating data; whether sourced from market data vendors, trade repositories, internal systems, or trading venues.
 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014R1286&from=en (I (6))
 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014R1286&from=en (I (7))