With the turning of the year, a cold snap often descends and while much of the world remains in lockdown, we often open the curtains to find the cold has covered our surroundings with a frosty and often beautiful veneer.
It is also evident that certain relationships between European Union (E.U.) policymakers have turned slightly frosty as some important regulatory deadlines loom large across industry and divergent opinion frays relationships a little.
In this regard, PRIIPs and SFDR come to mind - let’s explore this issue in more detail.
E.U. Rulemaking is Complex
Before addressing some of the current rulemaking tensions, for those not as close to the action, we should briefly explain exactly how E.U. financial regulation is made. Being brief is not easy when it comes to addressing the complexity of E.U. rulemaking, but let’s give it a go.
Generally, financial regulation is generated or amended by inclusion of a diverse but interconnected group of policy stakeholders across the spectrum of politics (E.U. Council and Parliament), administration (E.U. Commission) and supervision in the form of the European Supervisory Authorities comprised of ESMA, EIOPA and the EBA.
When the rules are fully formed and agreed by the E.U. institutions they are usually implemented in the form of:
- Regulation – directly applicable across all E.U. member states
- Directive – requiring national member state interpretation and implementation
The very fact that there are so many constituent parts in rule formation means that naturally, there is often disagreement and the passage of new regulation to implementation is rarely without bumps in the road.
However, some regulations cause more angst and conflict than others. The most divisive E.U. regulation in recent memory is PRIIPs, which has had E.U. policymakers locking horns for some time now. It has flared up once more recently with the European Commission looking to end the existing stalemate and bring PRIIPs towards its end game.
PRIIPs: Let’s Finish This One Way or Another
The latest flare up on PRIIPs, the problem child of E.U. regulation, comes by way of a letter from Mairead McGuinness, the EU Commission’s new financial services head to the European Supervisory Agencies (ESMA, EIOPA, EBA) and the main industry body, the European Fund and Asset Management Association (EFAMA) asking them once more to urgently conclude the final technical rules for PRIIPs by the end of January. Otherwise, the Commission will “take all necessary steps” to bring PRIIPs to conclusion. This hints at the fact that in order to draw the saga to a close, the regular implementation processes might be circumvented and national regulators, and by extension industry itself, may lose all opportunity to engage or comment on the final ruleset.
This could have negative practical consequence on the shape and timing of the new rules, particularly for UCITS funds, an important cornerstone of the E.U. retail funds market.
UCITS is perhaps the single greatest E.U. regulatory policy success ever. As such, any new requirement that has the potential to negatively impact UCITS gets a lot of airtime and this issue remains a red-hot topic for all UCITS managers.
Since its implementation, PRIIPs has faced continued criticism since its design is said to result in misleading investor disclosures, notably in the areas of costs and projected future performance metrics.
The reason PRIIPs remains such a hot and divisive topic is that UCITS funds currently enjoy an exemption from these PRIIPs requirements, but the exemption expires at the end of this year.
ESMA, which oversees the UCITS market, wants UCITS to remain exempt until such time that a better form of investor disclosure can be collectively agreed before drawing in a ruleset that it said in prior correspondence might be “detrimental to retail investors” compared to past performance disclosure.
If the Commission does ultimately impose the existing proposed ruleset on UCITS funds without further exemptions, it will be a challenge for UCITS fund providers both in terms of time to comply with the disclosures and the fact that the sub-optimal cost and performance disclosures might prove confusing to investors. Such a move might also possibly reduce confidence in the UCITS product that has continued to be successful in terms of attracting fund flows year on year, even in the face of market volatility, due to confidence in its design.
Furthermore, it could set a precedent where new rules might be enforced without considering either regulator or broader industry inputs which has been a factor in so many E.U. regulations being successfully implemented in practical terms historically.
It’s not just PRIIPs
The current interactions between Europe-wide regulators and the Commission are not exclusively reserved for PRIIPs. Another large regulation that is under tight scrutiny currently is the Sustainable Finance Disclosure regulation (SFDR), where certain requirements become applicable on March 10th (that’s 37 days from now).
This is a significant regulatory deadline, with certain ESG/sustainability disclosures having to be made by product manufacturers and for the fund products themselves. However, even at this late stage, the European regulators responsible for overseeing the new rules have asked for several clarifications from the E.U. Commission in the form of a January 7th letter.
The letter poses some technical questions regarding the scope, clarity of definitions, and interaction of SFDR with some other E.U. regulations. The fact that it comes so late in the day is indicative of the complexity of the requirements and difficulty that all stakeholders have in preparing for an important step in the E.U.’s journey towards enshrining ESG regulations. It is hoped that the regulators and Commission can come to a consensus position quickly, so that regulated entities in the scope of the rule can prepare themselves for the pending March 10th deadline.
The PRIIPs and SFDR issues are indicative of the importance of industry-wide dialogue on regulatory implementation to include all stakeholders with a view to rule certainty.
You won’t ever please all of the people all of the time, however a certain thawing of relations on regulations and a commitment to constructive and consultative dialogue is optimal in order to ultimately provide the best outcomes possible for underlying investors, who ultimately are the stakeholders most affected by such changes.