VGF s reply to European Commission s Consultation Paper on legislative steps for the Packaged Retail Investment Products initiative

Transcription

1 VGF s reply to European Commission s Consultation Paper on legislative steps for the Packaged Retail Investment Products initiative VGF Verband Geschlossene Fonds e.v. 1 would like to express its thanks for the opportunity to comment under the European Commission s Consultation Paper on legislative steps for the Packaged Retail Investment Products initiative. It remains unclear whether or not German non-tradeable closed-end funds (NTCEF) will be affected by the PRIPs initiative. Even though this fundamental question has not yet been answered, we feel that it is both reasonable and necessary to present our standpoints to the Commission today. Preliminary remarks German non-tradeable closed-end funds (NTCEF) have thus far remained outside the scope of European capital market regulations. Under German capital market supervisory law there is a provision regarding the drafting and approval of sales prospectuses. There are also industry standards such as the obligation to compile track records (annually published records of all results of all funds under management) and membership of the NTCEF ombudsman. Adherence to these standards is an essential prerequisite of membership of the VGF. With regard to PRIPs and MiFID, the suppliers of NTCEFs in Germany, do not currently fall under the scope of MiFID, because shares in NTCEFs are not considered financial instruments as defined in Art. 4, Para. 1, No. 18 MiFID (Federal Draft Law on FRUG - the German MiFID Implementation Act - Bulletin of the German Parliament BT-Drcks. 16/4028 of , p. 7 of the Explanatory Memorandum). Nonetheless, the national legislator is currently planning to include shares in NTCEFs as financial instruments by means of a law announced for 2011 (Act on the Amendment of the Investment Broker and Asset Management Law, Gesetz zur Novellierung des Finanzanlagenvermittler- und Vermögensanlagenrechts). As a result, the MiFID and planned revision will also be relevant to NTCEFs in the future. 1 The VGF (Verband Geschlossene Fonds Association of Non-Tradeable Closed-End Funds) is the interest group representing suppliers of non-tradeable closed-end funds (NTCEF) in Germany. Through its 59 members, the association represents some EUR 165 billion (portfolio of assets under management), managed in about 2200 funds. Related to the total market in Germany with a fund volume of some EUR 198 billion, the association therefore represents about 83 % of the NTCEF market. Further information is available at: The abbreviation VGF will be used in the following. Seite 1

2 When taking further steps at the PRIPs initiative and the MiFID review, we feel sufficient consideration should be given to the specific characteristics of German NTCEFs. As a specific type of investment strategy NTCEFs provide a means of entrepreneurial investment for a wide public. They are not found in the same form in other European member states. In that respect, German NTCEFs are a unique national product, and are so far not well known in the context of European financial legislation; German NTCEFs only came to the attention of the acting EU bodies during the legislative procedure surrounding the AIFM Directive. With regard to the PRIPs work, we understand that NTCEFs do not appear in the Study on the Costs and Benefits of Potential Changes to Distribution Rules for Insurance Investment Products and other Non-MIFID Packaged Retail Investment Products 2. We hope, in the future, to see the European Commission and the level 2 bodies affording greater consideration to the importance and concerns of NTCEFs in the context of European legislation, so that the implementation and application of European legislation can be geared to the practical needs of German NTCEFs. Essential characteristics of closed-end funds We consider it necessary to begin by explaining the essential characteristics of German closed-end funds: German NTCEFs are partnerships in which the capital provided by several investors is pooled to invest in assets which individual investors could not finance by themselves. This allows retail investors, with comparatively small sums, to participate in major investment projects such as an office building, or a container ship; such projects would otherwise attract institutional investors only.. 3 By investing in a NTCEF, the investor becomes a partner. For tax purposes, he or she is a co-entrepreneur. The goal is to share in the economic success of the project, e.g. in the rental income from real estate. The entrepreneurial character of NTCEFs does mean, however, that the investor also exposes himself to the associated economic risks. NTCEFs usually invest in assets which are defined in advance. No other assets are bought during the fund s lifetime. NTCEFs are designed and put together by legally independent suppliers, the issuing houses. They set up the investment company by drawing up a partnership agreement appropriate to the fund, they acquire the investment object and they ensure all the necessary contracts (e.g. partnership agreement, purchase/lease contract) are signed. Funds for offer on the open market must also be accompanied by a sales prospectus requiring the approval of the Federal Financial Supervisory Authority The total volume of all funds was around EUR 21m in 2010, the average investment was around EUR 26,000. Page 2

3 (Bundesanstalt für Finanzdienstleistungsaufsicht BaFin); the supplier is responsible for the content of the prospectus. The prospectus must provide potential investors with full and correct information about all key aspects of the investment prior to the acquisition of shares. A NTCEF is then usually sold to investors via commercial banks or independent investment brokers. Virtually all sales take place in Germany; small sales structures are also present in Austria. In traditional NTCEFs, the investment volume is fixed prior to placement. Minimum investment sums apply to shares in the fund, usually between EUR 10,000 and EUR 25,000. Answers to the Consultation We have taken the liberty to answer several closely related questions, with one response. Question 1: Should the PRIPs initiative focus on packaged investments? Please justify or explain your answer. Question 3: Does a reference to indirectness of exposure capture the packaging? As explained above, it is as yet unclear whether or not German NTCEFs will be subject to the PRIPs initiative. This shows that the current definition of PRIPs is not accurate enough. As described above, NTCEFs are designed by issuing houses. Issuing houses usually select one physical investment object, such as a real estate property, an aeroplane, or a ship. The next step is generally to set up a fund in the form of a German Kommanditgesellschaft, shares in which are subscribed to by the investors. Such funds are usually managed by the issuing house or an associated group company for the duration of their term. Designing and marketing a NTCEF by no means constitutes packaging or wrapping an existing financial instrument into a new product. Providers of NTCEFs design an investment vehicle of their own initiative. They explicitly do not wrap various financial instruments or assets but simply design a fund, which usually purchases and manages one single asset. NTCEFs will not be understood any more clearly if the PRIPs definition implies an indirect investment. It may be the case that participation in a NTCEF is an indirect participation in an asset, but according to the consultation document, indirectness should only be an evaluation criterion for whether or not a product has been packaged. This evidentiary effect does not work for NTCEFs because even if they are indirect, they do not package a bundle of various existing financial instruments. The concept of being indirect does not define the packaging. Page 3

4 In our view the approach of indirectness does not do justice to the special characteristics of NTCEFs. An investor in a NTCEF may make an indirect investment in an asset, but makes a direct investment in a fund, which in turn directly invests in, manages and generates profits from the asset. This by no means constitutes a complex product structure covering several levels which cannot be grasped by the investor. Ultimately, the PRIPs definition if at all only covers the aspect of other mechanisms than a direct holding of the business model of NTCEFs. In our view, the definition in particular with reference to the principle of clarity in the law is far too inaccurate and too vague. This is why we are sceptical as to whether NTCEFs should actually be subject to the PRIPs definition, and whether the mere fact that they are mostly sold by retail customers should automatically make them subject to PRIPs. If NTCEFs fall within this scope of application, their rather simple structure should be covered more accurately in the definition. Question 2: Should a definition of PRIPs focus on fluctuations in investment values? Please justify or explain your answer. Even for NTCEFs, the value of the investment depends on market fluctuations. However, we doubt that this criterion should be used and that it is reasonable to make the applicability of additional legislation dependent on this characteristic. The market fluctuation of the asset value does not have immediate consequences for investors in NTCEFs. During their maturity period, NTCEFs do not include a share redemption entitlement for the investor. As a consequence, while the value of an investment can theoretically be determined, it is of little practical consequence, as it is not realizable during the maturity period. In our view, this rather irrelevant characteristic, at least with respect to NTCEFs, is therefore not suitable as a basis on which to make additional measures dependent. Question 13: Do you see benefits from such an indicative list being developed? If not, please provide alternative proposals and evidence for why these might be effective. In terms of legal classification, a list of products to be covered by the PRIPs initiative does not make sense. The definitions for determining the scope of application of products covered by the PRIPs initiative should be clear. If such a list is necessary, this implies that the definitions are not accurate enough. Provided German NTCEFs were to fall within the scope of application of the PRIPs initiative, such a list would, however, offer the advantage that German NTCEFs Page 4

5 would appear in European legislation for the first time. Until now, European legislators have failed to provide a concrete description or even a definition of the product. Only their inclusion in the AIFM directive led to NTCEFs being seen as alternative investment funds (AIF) within the meaning of the AIFM Directive. However, the AIFM directive does not give a definition either. Consequently, a list under the PRIPs initiative would offer the possibility of providing a closer definition of NTCEF products through a legislative act for instance through a recital or even through set definitions. This would allow the product's special characteristics to be better explained for the first time. Question 17: Should the design of the KIID be focused on delivering on the objective of aiding retail investment decision making? If you disagree, please justify your answer. As long as the rules of a PRIPs KIID apply to NTCEFs, the KIID of course has to contribute to creating more decision-making scope, better comparability between various capital investment products, and thus better investor protection. Otherwise the costs would bear no relation to the benefits. It is, however, important to pay close attention to the special characteristics of the products and the investors in NTCEFs. It is understandable that the findings from the procedure for UCITS-KIID are to be applied to PRIPs-KIID, but there are considerable differences between the two projects: To start with, they concern different products and different investors. Unlike UCITS, PRIPs concern products which have not yet been harmonized. For this reason alone, creating comparability using a KIID would therefore be extremely difficult. To give an example, it is virtually impossible to clearly separate insurance products and NTCEFs from each other on a two-page KIID, and to enable investors to make the best possible choice. The product characteristics of NTCEFs also include their maturity periods. This will frequently be between 15 and 20 years. In contrast to open-ended funds, NTCEFs have a fixed start date and a clearly forecast liquidation date. Another factor is that investors make an entrepreneurial investment which furnishes them with the corresponding rights and duties. They enjoy entrepreneurial co-decision rights concerning the fund's strategies. Page 5

6 Another special characteristic of NTCEFs is the average investment amount. At around EUR 26,000 4, investors in NTCEFs are not typical retail investors, even though they are considered as such by the MiFID definition. The investor and the product structure thus show that the investors do not make random, but usually very well-considered, investment decisions. In order to make such decisions, they obviously require clear information. The KIID could make investment decisions in relation to NTCEFs easier, but generally, it will be necessary to look into the product more closely, for example with a consultation or with a sales prospectus providing additional information. Question 18: Should the KIID be a separate or stand alone document compared with other information that might be necessary, e.g. background information, other disclosures, or contractual information? Please justify or explain you answer. In our view, only a prospectus can reliably provide comprehensive and complete information. German law obliges providers of NTCEFs to publish a prospectus which has to be approved by the German Financial Supervisory Authority (BaFin). In addition, the AIFM Directive which will apply in future also contains the duty to provide potential investors with information about a product to allow them to make their investment decision. As long as such information can be summed up, creating a KIID will not do any harm. Nevertheless, such an information summary should not allow for important aspects of the investment decisions to become lost. Whenever key information can be provided in a KIID, this should always be considered in conjunction with the information provided in the (main) prospectus. After all, this is required under national liability case law. We are in favour of not creating additional liability rules through a KIID, in particular with respect to the completeness of information. VGF has recently prepared a so-called Vermögensanlageninformationsblatt (VIB), which describes the main characteristics of the NTCEF on three A4 pages. It offers the investors the most important information at a glance to help them make their investment decision. The VIB was prepared in response to plans for introducing a statutory obligation to prepare and provide such a VIB in Germany. 5 We suggest applying the lessons learned from this to the creation of a European PRIPs-KIID. 4 Source: VGF Branchenzahlen 2010, for more information go to: 5 Draft Act on the Amendment of the Investment Broker and Asset Management Law (Gesetz zur Novellierung des Finanzanlagenvermittler- und Vermögensanlagenrechts). Page 6

7 An attempt should be made to harmonize the various procedural levels. Frequent changes in information standards would place an undue burden on the industry and - above all - investors, and even create confusion. Question 20: While the same broad principles should be applied to all PRIPs, should detailed implementations of some of these principles be tailored for different types of PRIP? Please justify or explain your answer, and provide examples, where relevant, of the kinds of tailoring you might envisage. Question 21: Do you foresee any difficulties in requiring the KIID to always follow the same broad structure (sequence of items, labelling of items)? Please justify or explain your answer. Question 22: Do you foresee any difficulties in requiring certain parts of the key information and its presentation (e.g. on costs, performance, risks, and guarantees) to be standardised and consistent as possible, irrespective of tailoring otherwise allowed? Please justify or explain your answer. Question 23: Can you provide examples and evidence of the costs and benefits from your experience that might be expected from greater standardisation of the presentation and content in the KIID? Question 24: Should the content of the KIID be controlled so that there is no possibility for firms to add additional information unless expressly allowed for? As already mentioned, we feel that providing harmonized information on nonharmonized products is difficult to achieve. There should therefore be options for adapting the information for special national products. There are also other mainly factual reasons that speak against standardized and harmonized information on NTCEFs. Since this branch of the financial industry is typically German and almost exclusively attracts German investors, European harmonization for NTCEFs seems neither advisable nor reasonable. There is only little practical need to compare products at a European level. There are hardly any cross-border sales of NTCEFs. 6 The special characteristics of German tax and corporate law generally make NTCEFs attractive to German investors only. The products have been geared to the German market. Initial considerations of German legislators concerning the implementation of AIFM show that this will remain so; the German legislator is considering creating purely national product rules for selling to retail investors. We do not, therefore, expect the creation of an internal market any time soon. An initial cost-benefit analysis of a harmonized European PRIPs-KIID has therefore shown unfavourable results. 6 The only exception may be Austria with some minor sales for German providers of NTCEFs. Page 7

8 For NTCEFs, setting certain criteria and sequences of criteria is not beneficial. The Commission's proposal to show costs, performance, risks and guarantees in a uniform way seem difficult to realize, simply because for NTCEFs, which each constitute a new, tailored investment, it is impossible to provide information on expected performance based on past performance, as no past performance exists. Question 25: Do you foresee and difficulties in applying these broad principles to the KIID for all PRIPs, as the building blocks on content and format for a 'level 1' instrument? Please justify or explain your answer. Question 26: Are there any other broad principles that should be considered on content and format? At level 1, the content of a PRIPs-KIID should only set broad principles. More concrete principles must be left to the 'level 2' instruments or even to national implementation measures. This also applies to the scope of the PRIPs-KIID. Whilst preparing the Vermögensanlageninformationsblatt (VIB) for NTCEFs, VGF realized that fitting a reasonable explanation of the product and its essential characteristics on two pages is virtually impossible. In our view, at least three pages are necessary. Limitations in scope would be at the expense of investors, who, as a result of fewer pages of information, would receive less comprehensive and less clear information. In our view, it seems difficult to set the measure of an average investor. Average investors in NTCEFs differ from average investors in other PRIPs, and they certainly differ from average investors in the market as a whole. We would like to stress once again that investors in NTCEFs are frequently not typical retail investors, but extremely well-informed and very critical clients who are prepared to make a fixed investment of relatively large amounts in the long term. 7 When using an 'average investor as a yardstick for a PRIPs-KIID, 'average' should refer to PRIPs investors or even to a particular product. Question 27: Should product manufacturers be made generally responsible for preparing a KIID? Please justify or explain your answer. Question 28: Are you aware of any problems that might arise in the distribution of particular products should responsibilities for producing the KIID be solely placed on the product manufacturer? 7 Also see question 17 et.seq. Page 8

9 Question 29: If intermediaries or distributors might be permitted to prepare the documents in some cases, how would these cases be defined? In our view, a KIID should always be prepared by the provider. The provider is in the ideal position to describe a product in whose design he/she has been involved. Question 32: Should the summary prospectus be replaced by the KIID for PRIPs? Please outline the benefits and disadvantages you see with respect to such an approach. Question 35: Are there any disclosures, e.g. required by the existing regimes, which you believe the PRIPs KIID should not include, but which should still be disclosed, e.g. separately to the KIID? Do you have any practical examples for such elements? As mentioned above, there are no European Directives for the preparation of prospectuses or short prospectuses on NTCEFs. The Prospectus Directive does not apply to NTCEFs because such shares are not tradable as securities. The PRIPs regime should absolutely observe national German law, which provides for an obligation to prepare a prospectus on a public investment product, and for such a prospectus being approved by BaFin. In our view, only a complete prospectus can provide an accurate description of a product. In view of existing rules on summarized information we would like to refer once again to the Vermögensanlageninformationsblatt (VIB) for NTCEFs which was prepared by VGF currently. The draft of a Act on the Amendment of the Investment Broker and Asset Management Law (Gesetz zur Novellierung des Finanzanlagenvermittlerund Vermögensanlagenrechts) also reflects the efforts of the German legislator, to make this a requirement for NTCEFs in the future. We therefore suggest, once again, drawing on the lessons learned by the German legislator and by VGF to create a PRIPs-KIID which is as practice-oriented as possible. We would be very happy to discuss details of our VIB as soon as possible. 8 Question 36: What in your view will be the main challenges that will need to be addressed if a single risk rating approach is to work for all PRIPs? Question 37: Do you consider there are any other techniques that might be used to help retail investors compare risks? 8 Please contact Gero Gosslar at the Brussels office of VGF: gosslar@vgf-online.de; P , F Page 9

10 In view of the risk / reward' criteria we would like to point out that we would be sceptical towards any deliberations to introduce an indicator. It will be virtually impossible to include the risks of different product in a common risk scale. In our view, this would inevitably lead to false assessments and misguidance in terms of too much and too little risk. The question of how the risk of a particular capital investment should be rated depends on the perspective of the investor. Something which may be considered high-risk by certain groups of investors may be considered low-risk by other groups of investors. A graphical representation or chart creates the risk of wrongly influencing in favour of, or against, an investment decision. The only possibility of conveying an investor a true and correct picture of the risks and opportunities of a product are verbal descriptions. Question 38: What in your view will be the main challenges that will need to be addressed in developing common cost metrics for PRIPs? Question 39: How can retail investors be aided in making 'value for money' comparisons between different PRIPs? Presenting the costs of NTCEFs could lead to unsatisfactory results because this model's cost structure generally deviates strongly from that of other products (such as open-ended funds). It is therefore difficult to make a fair comparison. The sales costs for NTCEFs, for example, are always incurred once when the investment is subscribed to. Unlike with open-ended funds, ongoing commissions are not payable during the term of the fund. It is to be doubted whether investors will recognize this clear difference from reading a KIID. This could lead investors to wrongly believe that the up-front costs of a NTCEF are higher by comparison. We feel that the representation of costs should have the purpose of providing extensive information to the investor about the way the money is used, instead of suggesting that a NTCEF is comparable with other PRIPs in a way which is possibly not realistic. Question 40: Do you consider that performance information should always be included in a KIID? If NTCEFs had to prepare a PRIPS-KIID it would be impossible to provide information on performance. Since - unlike open-ended funds - NTCEFs are always newly set up, there is no past performance. The only conceivable performance information would be a forecast on planned payments. However, the closed nature of a NTCEF makes it difficult to compare with other products which do not share the key characteristics of NTCEFs. Page 10

11 Question 42: Do you agree that a consistent approach to the description of guarantees and capital protection in the KIID should be sought, e.g. through detailed implementing measures, for different PRIPs? Question 43: What information should be provided to retail investors on the cost of guarantees? Once again, we would like to point out that NTCEFs do not contain guarantees as a matter of principle. An entrepreneurial investment in a non-profitable product could, therefore, also lead to total loss. NTCEFs therefore do not guarantee capital preservation. They do, however, grant investors industrial co-decision making rights through direct involvement in the fund strategy. February 2011 Attorney-at-Law Eric Romba Chief Executive Officer VGF Verband Geschlossene Fonds e.v. Association of Non-Tradeable Closed-End Funds Berlin Office: Georgenstraße Berlin Germany P +49 (0) F +49 (0) kontakt@vgf-online.de Brussels Office: 47 51, rue du Luxembourg 1050 Bruxelles Belgium P +32 (0) F +32 (0) contact@vgf-online.eu Page 11