The EU Retail Investment Strategy and Private Fund Managers

The European Commission published its Retail Investment Package (the Package) in May 2023. The Package aims to streamline and modernise investor protection rules in EU laws, including the Alternative Investment Fund Managers Directive (AIFMD) and Markets in Financial Instruments Directive (MiFID), with the aim of increasing the level of retail investment in the EU.

Not only is the Package relevant to private fund managers that wish to bring retail investors into their funds, but it introduces rules that would apply to all investors.

Of particular interest for EU private fund managers (and discussed in more detail in this briefing) are the proposals set out below.

• First, the introduction in AIFMD of the concept of “undue costs” for AIFs (developing the recent European Securities and Markets Authority (ESMA) Opinion) and the introduction of a value-for-money concept with respect to retail investors. These retail-investor-specific provisions would supplement other provisions in the current AIFMD II proposals on enhancing retail investor access (see our most recent AIFMD II Alert.)
• Secondly, changes to the MiFID definition of “professional client” that will expand the categories of person who can invest in an AIF, noting the cross-references from AIFMD to MiFID. 
• Thirdly, a ban in MiFID on inducements for non-advised sales of retail investment products, which may have an impact on private placement agents and the other distributors of private funds.

The Package also seeks to make amendments to MiFID to improve product transparency, address marketing via social media, and improve cooperation between regulators. Further, it seeks to amend the Regulation on Packaged Retail and Insurance-Based Products (PRIIPs Regulation), relevant to the distribution of private funds to retail investors, to improve the digital readability of key information documents (KIDs) and address the disclosure of sustainability-related information.

The proposed AIFMD, MiFID and other changes in the Package are unlikely to come into force before the end of 2025, and for many of the proposed requirements, delegated legislation is to follow setting out further detail.

Managers should, nevertheless, keep a watching brief and start to make plans around compliance, in particular: incorporating a more granular approach to costs and charges to supplement their governance structures in providing “value for money”; revisiting fee models for those who provide products via execution-only distribution chains; and considering if the proposed amended elective professional opt-up regime would help to recategorise any retail wealth investors.

1. The Undue Costs Requirements

The current provisions in the AIFMD delegated regulation to ensure that costs are not undue are to be clarified and enhanced (as well as converged by being applied in both AIFMD and the Undertakings for Collective Investment in Transferable Securities, or UCITS, Directive). National regulators could oblige AIFMs to compensate investors where undue costs have been charged. The principles being consulted on are mostly in line with ESMA’s 17 May 2023, Opinion on undue costs; although (in points of contrast) the European Commission is pursuing objective benchmarking and does not propose to follow ESMA’s suggestion of referencing all PRIIPS KID costs for those that are eligible for assessment.

AIFMD is proposed to be amended to prevent undue costs from being charged to AIFs and their investors (of all categories), by setting out when costs will be considered “due.” It pertains to costs that are:

• in line with disclosures in the fund constitutional documents and any key information documents
• necessary for the AIF to operate in line with its investment strategy and objective or to fulfil regulatory requirements (although “necessary” is not defined)
• borne by investors in a way that ensures fair treatment of investors (although this does not prevent provisions allowing for preferential treatment where it is disclosed in the fund’s constitutional documents under AIFMD)

In addition, in order to implement the value-for-money principle for retail investment products, new AIFMD product governance rules are proposed. These would require an AIFM to set out a “pricing process” allowing for the identification and quantification of all costs and charges borne by the AIF and its investors, and an annual assessment (and onward regulatory reporting) of whether the costs borne by retail investors are justified and proportionate, having regard to the AIF characteristics (including its investment objective, strategy, expected returns, level of risks, and other relevant characteristics).

ESMA is mandated to publish performance benchmarks against which an AIFM must compare costs and performance of its AIFs that are offered to retail investors. A review is anticipated within five years of the amending legislation coming into force. Similar requirements on disclosures of costs and charges are to be introduced for MiFID investment firms.

Much of the detail will follow in secondary measures, and one of particular note will be to ascertain how the objective benchmarking concept will work for diverse and cross-sector private investment fund strategies.

2. Broader Criteria To Qualify As A “Professional Investor”

There are three limbs to this proposal (by way of amendments to Annex II of MiFID II), designed to ease restrictions for investors to opt up to qualify as professional and reduce administrative burdens. The assessment for the opt-up still applies where two of the criteria are satisfied (therefore extending the eligibility). The proposed amendments are to:

• reduce the wealth criterion from €500,000 to €250,000 (measured on average over the preceding three years) 
• extend the criterion of having worked in the financial sector for at least one year to include those who have undertaken capital market activities requiring them to buy and sell financial instruments and/or to manage a portfolio of financial instruments
• add a fourth criterion of proof of recognised education or training that evidences someone’s understanding of the relevant transactions or services envisaged and ability to adequately evaluate the risks

In addition, a new proposed criterion will allow legal entities to qualify as elective professionals if they meet two out of three requirements (€10 million balance sheet, €20 million net turnover, and €1 million own funds) and the individual responsible for the transaction understands the relevant transaction or services and is capable of making the relevant investment decisions and of evaluating the risks.

3. Ban on Inducements For Non-Advised Sales of Retail Investment Products

The proposal is to ban inducements (any kind of payment, such as commission, or nonmonetary benefits) paid from manufacturers to distributors in relation to reception and transmission, or execution of, orders to or on behalf of retail clients.

This impacts those manufacturers and issuers providing execution-only distribution chains. It will exist in addition to the existing ban on inducements on portfolio management and independent advice (e.g., payments relating to research and the provision of investment services). However, it does not impact fees or other remuneration, including in situations where investment firms provide advice to the same client relating to one or more transactions covered by that advice.

For advised sales, a new “best interest of the client” uniform safeguard procedure is proposed, in particular a strengthened test to ensure that distributors act honestly, fairly, and professionally in accordance with the best interest of their clients, as well as firmer transparency requirements.

There is to be a review on the impact of third-party payments on retail investors three years after the amending legislation comes into force.

Another milestone towards the “retailisation” of investments that would otherwise only be available to professional investors relates to the ELTIF reform, which entered into force in April this year and applies from 10 January 2024. In that context, you may also be interested in our recent briefings ELTIF Regulation regulatory technical standards (RTS): Important detail in the ESMA consultation and ELTIF Reform: A Milestone in the Development of an EU Private Fund Structure for Accessing Wholesale Markets.

To discuss the contents of this alert, please contact the authors or your usual Goodwin contact.