ESMA advises investment firms against using artificially low costs to mislead clients
The European Securities and Markets Authority (ESMA) today updated its Questions and Answers on the implementation of investor protection topics under the Market in Financial Instruments Directive and Regulation (MiFID II/ MiFIR).
The Q&As on MiFID II and MiFIR investor protection and intermediaries’ topics includes three new Q&As on ‘product governance’ that aim to give guidance on how firms issuing financial instruments should ensure that:
- financial instruments’ costs and charges are compatible with the needs, objectives and characteristics of the target market;
- costs and charges do not undermine the financial instrument’s return expectations;
- the charging structure of the financial instrument is appropriately transparent for the target market, ensuring that it does not disguise charges or is too complex to understand.
ESMA notes that target clients should be able to access and choose the product(s) that best serve their needs, objectives and characteristics by assessing all relevant costs and benefits of the product(s). Therefore, during the product design phase the firm should ensure that the charging structure of the product is not opaque, hard to assess or designed to mislead clients and to exploit behavioural biases.
The regulator expects firms to:
- Ensure that artificially low initial rates/costs are not used to attract and mislead unsophisticated clients.
- Avoid the use of unnecessarily complex formulas for the determination of costs.
- Avoid too many cost components or unnecessarily splitting cost components in too many elements if this reduces clarity.
- Consider, in cases where the cost structure is particularly complex, the possibility of some form of testing of the cost disclosures to ensure that these are not too complex to understand based on the characteristics of the target clients.
- Assess whether there is no duplication of costs (e.g. the same type of fee is not included in two different cost categories) and ensure that costs are properly separated and accounted for.
Regarding how firms should ensure that costs and charges do not undermine the financial instrument’s return expectations, the regulator advises that, during the product design phase the firm may undertake a scenario analysis of their financial instruments and, in this context, simulate product returns taking into account all costs of the instruments.
The purpose of the MiFID II/MiFIR investor protection Q&As is to promote common supervisory approaches and practices in the application of MiFID II and MiFIR.