MiFID II defines certain products as non-complex. Other products may be tested against a set of criteria, on a product-by-product basis, to decide whether they are 'complex' or not. Only products that are non-complex can be sold without the application of an 'appropriateness' test, i.e. can be sold on an execution-only basis.
The Directive requires further elaboration of these criteria to be provided in Level 2 measures, on which the European Commission sought the advice of the European Securities & Markets Authority (ESMA). ESMA’s final advice to the Commission in this area is little changed from the draft it issued for consultation in May 2014. In particular, it suggests that certain products be automatically defined as complex (i.e. they would not be tested against the criteria), which would mean they could no longer be sold on an execution-only basis.
Many Member States have types of AIF that are subject to additional rules, which enable them to be sold to retail consumers, including on an execution-only basis. States have historically authorised non-UCITS retail funds. These tend to be open-ended funds that are subject to the same general governance and operating rules as UCITS, including restrictions on their investments and diversification requirements. However, the rules differ in one or two ways from UCITS.
Also, some States have specific rules for listed, closed-ended funds that make them suitable for retail investors. Again, these sorts of AIF are often subject to similar rules as UCITS but they are not open-ended so cannot be UCITS. And some States have special funds that encourage retirement savings by the application of special tax treatment.
The AIF population is wide and diverse. It covers plain vanilla non-UCITS funds through to highly leveraged hedge funds with complex pay-out structures. Any rules that take a one-size-fits-all approach to AIFs will most likely lead to perverse outcomes for consumers.
Furthermore, the advice cuts across the increasing trend for investors to use internet-based channels to purchase investment products. They may have sought financial advice beforehand, which they have paid for on a fee basis, or they may have done their own research into different products.
ESMA’s proposal to the Commission would therefore lead to a sharp reduction in the number and types of investment products that can be sold on an execution-only basis. Moreover, it would result in products that provide similar economic exposures and similar investor protections being differently treated.
It is now for the Commission to decide on the shape of the final Level 2 measures, expected by June 2015.