Update: EC Prips Regulation due for publication on July 3; latest draft shifts burden further towards structured product creators

Europe's laws on the key information document (Kid) and packaged retail investment products (Prips) are scheduled for implementation on July 3. The latest draft suggests more onerous responsibility for product providers

EC takes a closer look at the responsibility of the creator

The near final text of the European Commission's (EC's) packaged retail investment products (Prips) regulation has added 'reverse burden of proof' to the previous draft and aimed responsibility for the creation of the key information document (Kid) squarely at investment banks, reflecting a harder line taken by the EC on the creation of investment products by investment banks for retail investors.

"I am not surprised," says Tim Hailes, chairman of the Joint Associations Committee (Jac) and associate general counsel for structured products at JP Morgan in London, "although I am rather disappointed".

"If you look at many of the amendments to the Markets in Financial Instruments Directive (Mifid) currently being tabled by MEPs, there are some pretty radical things going in there, so I suppose it is reflective of an environment of general hostility to investment banking in some political quarters, especially when it concerns the consumer protection agenda," says Hailes.

If the Kid is just speaking to the fundamentals of the product, manufacturers are supportive. "The broad principle for having a reasonable requirement of what goes into a Kid and a liability for then failing to comply with that is acceptable; a reverse burden of proof and/or vague and broad content requirements is not," says Julian Velarde, head of derivatives, corporate and investment banking legal at BNP Paribas in London.

"The European Commission recognises that product disclosure documents are usually drafted for plaintiffs' lawyers, and that's what they are trying to get away from, and that's a very good aim," says Velarde. "It will be very useful for investors to not have a defensive document that is written for litigation, but rather as a short, succinct document that gives them the key ideas they need. We would, however, prefer that there is no liability for what is intended to be a short summary document in order that the focus can exclusively be on key disclosures."

The EC appears to have settled on a halfway house in the latest draft, which, subject to the level two (member state implementation rules), defines what goes into the Kid fairly broadly. The document requires that the creator must inform on the risk-reward profile, with the liability standard stated as "failure to comply with the regulation" and, it can be assumed, the level-two implementation measures.

The remedy would be damages - although it is not clear whether this would be consequential damages or the full extent of the liability. The draft simply says that failure to comply with the regulation exposes the product manufacturer to "any damage caused to that retail investor".

The payment of damages to be made by the private sector, whether intentional or not, would dovetail neatly with the talk of the creation of a Europe-wide deposit insurance scheme, whereby the public sector would compensate investors for certain losses.

Of the national first movers, Germany created legislation that puts the responsibility for the creation of the Kid on the product distributor. In the Ucits legislation, the responsibility for the Kid has been directed at the fund manager, which makes the latest shift by the EC consistent with Ucits.

"We strongly encourage European Union institutional bodies to take as best practice those documents already being used in member states that have a sophisticated and diversified retail product landscape, such as Germany, where product information sheets – Produktinformationsblätter – are already used," says Thomas Wulf, Brussels-based secretary general of the European Structured Investment Products Association (Eusipa).

The draft Prips regulation was scheduled to be implemented on June 20, but has been nudged forward to July, confirmed an official within the EC. London-based market professionals suggest the regulation would be implemented on Tuesday 3 July.

The creation of the Prips regulation coincides with amendments to the EC's Prospectus Directive (PD). "There is a contradiction in what is happening to the Kid, which broadly I'm supportive of, and what is being done on the PD amendment, where a huge amount of time, effort and cost will go into the form and number of base prospectuses... if the Commission believes that a Kid is required because investors do not read or cannot understand prospectuses, why constrain the future pool of potential retail investments with burdensome and costly requirements?" asks Velarde.

Wulf says: "We support the notion in Prips that the key information material needs to be in line with other compulsory product-related material, such as the prospectus, but we feel it is important that the character of the Kid is retained – that is, that it sticks to outlining key features of the pay-out structure, for example, but does not stray into multiple scenario analysis of the underlying asset. It must be kept clear and easy to read."

The draft Prips regulation also requires that product manufacturers must establish complaints procedures in relation to the Kid, going against the model of most structured products creation, distribution and sales, which are generally based on an intermediary model that leaves no contact between the creator and the retail investor. "Our people are not authorised to deal with retail customers, which is why we do it through intermediaries that are," says Hailes.

Questions still remain, however, about the proscriptive content for structured securities relative to structured funds, which would suggest that this issue is likely to be handled by national regulators. "You should not be putting asset management-style concepts into structured securities; they are not funds," says Hailes. "We have very consistently made this point about round pegs being forced into square holes to the commission."

Latest intelligence suggests that structured deposits will be covered by the Kid, as will simple, market-access, P-note, delta 1 type products, although it is unclear why the latter should be included if there are no 'bells and whistles' when shares and bonds are not, says Velarde.

Certainties that do flow from the draft are that the creation of structured products will be more costly and will take more time. Direct costs – that is, distribution costs – will be borne by the investor, as will indirect costs, which touches on the sensitive topic of what margin the creating bank pays for its funds.

The draft regulation states that the official language of the relevant market must be used in the Kid, which is not a surprise as it coincides with the general practice, but this will add time and expense, especially for products issued across the region, participants say.

"Highly prescriptive rules would not necessarily be a bad result," says Hailes, noting that this would make it more straightforward for product creators to know their exact liabilities.