European Commission goes all-in on PRIIPs comprehension alert

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This week, the Commission published its revised version of the PRIIPs Delegated Act which includes one of my babies, the comprehension alert.

To my great surprise, rather than interpreting the conditions for applying the comprehension alert, the Commission chooses to be much more ambitious and refer to MiFID’s Article 25 definition of non-complex products which might be sold on execution-only basis without a suitability test. Any product which is not a non-complex product will have to carry the comprehension alert, in the Commission’s proposal.

In this article, I consider whether such an approach will help to achieve the underlying original objective of the comprehension alert: to steer consumers away from products that are probably not good for them, but only good for the issuer of the product, and encourage consumers to challenge manufacturers of investment products on why these need to contain complex product features and pay-off formulas.

First of all, it’s amazing to see how many consultancy firms helping industry implement PRIIPs have not been able to understand the context of this particular feature of PRIIPs from the records of political negotiations and related press statements (some did get the idea at the time). Instead, they are following a very strict legal interpretation of the PRIIPs Regulation and finding it hard to understand what on earth is a “comprehension alert”.

Perhaps that is because it was never intended as a comprehension alert, really. It used to be called a complexity label (cf. the Parliament’s negotiation position – Article 8a), until that language was watered down in inter-institutional negotiations, and we had to scramble together a new text for the alert itself.

Five years ago when I was at Finance Watch, we campaigned for the inclusion of a complexity label to push consumers towards more straightforward and indeed simpler products. National experience had shown that such a label (on/off), traffic light or alternative rating system could help to “stigmatize” products that typically attract high fees for managers or expose consumers to uncommon tail risk. Through the stigma of a label, these products would be pushed out of the market as consumers would start asking their advisor why there was such a label on the product and what it meant (pretty much like the energy efficiency label on your new fridge or house).

We developed quite a lot of material to convince Member States of this idea, including a technical briefing still available online. The briefing argues that there are common elements to existing national frameworks for product rules, and converts best practise into a list of six recommended criteria (see page 16 and 17). There is also an excellent public webinar using some of the slides we used to convince Member States back in the days explaining the background of all this.

While we worked to ensure Member State support, MEPs in ECON formally proposed amendments introducing a complexity label based on these six criteria (Article 8a above). Although we could not get majority support for outright product rules, the complexity label that we asked MEPs to propose was accepted in the inter-institutional compromise reached on 1 April 2014, in the form of a comprehension alert with three typical situations mentioned in a Recital (the famous Recital 18). We were confident that with these three, at least a significant number of products would be captured by the label and hence their issuers put under pressure to justify their added value to consumers.

I had expected the Commission to interpret these three (and only these three!) criteria into more detail to ensure consistent application of the rules by manufacturers throughout Europe (it is the issuer of a product who has to decide whether or not to apply the label – there is no supervisory guidance or approval procedure at national level).

However, the Commission has decided to go beyond that and simply require that the label applies to all products not explicitly considered non-complex and therefore suitable for execution-only distribution (as defined in Article 25 of MiFID). This means the alert will apply to a much larger set of products than we initially envisaged with the full set of six parameters for the complexity label. The decision reverses the logic of an indicative list of product features that require the label, into an exhaustive list of features that are allowed in non-labeled products.

So what to make of this all-in bet?

  • The financial industry asked for legal certainty, and indeed the Commission proposal does have the merit of providing legal certainty.
  • Consumers will start to see the label in early 2018, and whatever it is based on, as long as it appears on a significant number of products it will trigger debates about the excessive complexity of products sold to consumers, often only to hide fees in layers.
  • But there is another side of the coin – the risk that almost all PRIIPs are labelled, with the risk that the label becomes meaningless. Industry participants such as AFG (in their ESMA consultation response) and DDV (in their 21 December 2016 letter) have actually warned for this. And perhaps some in the industry won’t mind this outcome, in order to suggest removal of the label once the planned review of the label foreseen by 31 December 2018 (one year after its introduction!) comes around.

We will see the cards soon. Coming to millions of financial products near you, early next year.