Investors are seeking new ways to access the market as a means to swerve volatility in the broader markets. Structured products can be honed specifically to the investor’s needs and have, thus, proved popular. But care is needed when it comes to forthcoming adaptations to rules; defining the target market, and the methods used in matching products to investors could be an issue.
The industry also needs to incorporate ESG criteria into the process, further complicating things. Markets in Financial Instruments Directive 2 (MiFID2) and Packaged Retail Investment and Insurance-based Products (PRIIPs) regulations are already established in the UK and EU - they both include structured products. But changes are afoot.
The aim of PRIIPs regulation is to encourage efficient EU markets by helping investors to better understand and compare the key features, risks, rewards, and costs of different PRIIPs, through access to a short and consumer-friendly Key Information Document (KID).
But UK PRIIPs are diverging from EU PRIIPs rules. Going forward, there will be different distribution rules; the EU is also changing its methodology on the product governance side. In addition, ESG and sustainability measures are now kicking in too. In the same vein, there are also to be a few amendments to MiFID2 and the Insurance Distribution Directive (IDD). Both strengthen investor protection and serve to improve efficiency, resilience, and transparency.
Finally, costs and charges are coming to prominence on the radar, and cost disclosure has become an issue. This is quite topical and is now firmly on the radar with supervisory visits and letters to distributors to make them aware. Manufacturers and distributors alike, thus, need to be on their toes!
“It is an evolving situation, and the market is looking at how to review what has been learned over the past few years. There are still some issues that need ironing out on the criteria that manufacturers and distributors use to define the ideal investor for a particular product,” says Ayal Leibowitz Founder and President of Futora.
He says there was lots of work done in 2018 when MiFID2 came in, and now, that there are to be further changes, some refinement of working practice is needed. “One area, in particular, is to streamline how the market is working. As an industry, we have to agree on standards and how manufacturers and distributors share information and regulatory information streams. This touches PRIIPS, MiFID2, and ESG regulation,” he says.
PRIIPS
He explains that as things stand, PRIIPs regulation is aligned between the EU and UK but that two separate regimes will soon be in place. Thus, there will be the need to work with both methodologies, content, and the like. “All the changes are on the manufacturing side, but distributors need to think about who the end client is so that they can apply the relevant methodology,” says Leibowitz.
The market is well aware of this, and one of the key issues is that there are various deadlines for implementation and change, thus making adoption something of a moving goalpost.
“The most significant change in the UK is that performance information narratives will replace performance scenarios to describe the impact of various factors on performance. The need to align narratives and have similar wording as comparability is key in PRIIPs,” he adds.
With that in mind, the UK regulator has given the market criteria to define a target investor; client type, ability to bear losses, knowledge and experience, risk tolerance, and objectives and needs.
Those criteria alone generate a large volume of data points – all intended to help the manufacturer define a target investor – as well as those that would not be suitable. And under MiFID2, clients’ sustainability preferences also need to be considered, which adds in more data points to determine whether a client is compatible. That will require a new template, and for that, there is work to do there.
All the information is then passed down to distributers, who must make sure that their clients are properly segmented to be able to accurately match their clients to a given product. There is an out-of-target market section that lies in between.
“This is not an absolute, and it is down to the distributor to find a holistic approach and decide on a case-by-case basis. The flow is where the manufacturer defines target market and distribution, and then helps them understand the product's characteristics to make sure the right products get to the right clients,” says Leibowitz.
He explains that although much of this is not new, the idea is to refine criteria and make better use of data points so that the process is clear, usable, and more standardised. And this is where technology can help.
“To what extent can this be automated? It is still a manual effort to categorise and feedback and identify exceptions, and that just does not work. There are lots of data points that need to be optimised and processed, and we should keep in mind that this all needs to be managed. And this will only increase as we adopt sustainability criteria,” says Leibowitz.
“Sometimes you get a product with a new feature, so that throws people and makes it harder to define who the target investor would be. Then investors themselves need to be classified according to knowledge and experience – so there needs to be rules around that and we need to automate that too. Then there is the matching process where products are matched to the investor,” he explains.
By harnessing data management, the result would be harmonisation – of the product description, target investors, and actual clients.
“What is needed is automated and process management to make sure that the target market as defined by both manufacturer and distributor should be harmonised as far as is possible,” Leibowitz concludes.
