A Key Information Document Helps to Turn Retail Clients into Mature Investors

On 4 November 2015 the Swiss government published the dispatch on the Financial Services Act (FinSA). In line with international standards, the FinSA will introduce an obligation for financial service providers to make a key information document available to retail clients, when offering them financial instruments. According to the dispatch, the aim of the proposed information document is to provide to retail clients “the information which are required, to treat them as “mature” investors, capable of taking responsibility for their own investment decisions”.

By Enrico Friz (Reference: CapLaw-2016-5)

1) Key Information Document as International Standard

One of the common regulatory themes that have developed across a number of jurisdictions since the onset of the financial crisis is the desire to increase investor protection at the point of sale. In this context, the International Organization of Securities Commissions (IOSCO) and other international groups have proposed the introduction of a short-form or summary disclosure, either to be provided separately, or as part of a broader disclosure document, particularly where the disclosure document is lengthy (see as an example: IOSCO, Regulation of Retail Structured Products, http://www.iosco.org/library/pubdocs/pdf/IOSCOPD410.pdf, in relation to a possible “regulatory toolkit” for retail structured products). Such summary disclosure is envisaged to include, amongst other key information, product description, potential downside risks, details of any applicable guarantees, scenario analysis, risk indicators, secondary market opportunities and comparisons to alternative investment products.

The Swiss Financial Market Supervisory Authority (FINMA) had come to similar conclusions in its “position paper on distribution rules” and had recommended the introduction of a concise and easily comprehensible document to be made available for all compound financial products offered to (retail) clients in Switzerland (FINMA, Regulation of the production and distribution of financial products (FINMA position paper on distribution rules), 24 February 2012, Key points 1 to 3). An equivalent document had already been introduced in 2007 for structured products, in the form of the Swiss simplified prospectus according to article 5 of the Collective Investment Schemes Act (CISA). Similarly, the CISA required the publication of a simplified prospectus for certain types of collective investment schemes, which as of June 2013 was replaced for securities funds and funds for traditional investments by a “document with key information for investors” (article 76 (1) CISA).

In its dispatch, the government takes up the FINMA recommendation and proposes to introduce a key information document (KID; Basisinformationsblatt) for all financial instruments offered to retail clients, which for structured products will replace the simplified prospectus and for collective investment schemes the relevant key information document. The main goal of a standardized KID is to allow retail clients to easily compare the key features of different investment products and, thus, to assist them in their investment decision. The proposal is comparable to the EU regulation known as PRIIPs (Regulation (EU) No 1286/2014 of the European Parliament and of the Council of 26 November 2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs)), which introduced the obligation for a key information document for packaged retail and insurance-based investment products.

2) What are the key requirements of the Regulation?

Article 60 FinSA states, that where a financial instrument is offered to retail clients (i.e., clients which do not qualify as professional clients, which includes all individuals, except the high-net-worth individuals who opted out in accordance with article 5 (1) FinSA), the manufacturer must first produce a KID. If the financial instruments are offered on an indicative basis, i.e. prior to all their terms having been fixed, at least a draft version with indicative information must be produced.

a) What financial instruments need a KID?

A KID must be produced for all types of financial instruments (as defined in article 2 (h) FinSA) offered to retail clients, other than shares and share-like securities allowing for participation rights, such as participation certificates and dividend rights certificates. Besides structured products and units in collective investment schemes, for which similar information documents are already required, the definition also includes plain vanilla debt instruments, which are out of scope of the PRIIPs. In addition, also derivatives (defined in article 2 (c) of the Financial Market Infrastructure Act as financial contracts whose value depends on one or several underlying assets and which are not cash transactions) will require a KID to be offered to retail clients. Derivatives do not need to be issued as securities, which are suitable for mass trading (such as warrants or mini-futures), but include also bilateral swap agreements and other OTC derivatives offered to retail clients. A KID is also required for redeemable life insurance policies with price-dependent benefits and settlement values as well as capital redemption operations and tontines and for deposits whose redemption value or interest is risk- or price-linked, excluding those whose interest is linked to an interest rate index.

b) Who is responsible for preparing the KID?

According to the proposal, the manufacturer of the financial instrument must produce the KID (article 60 (1) FinSA). For securities, the manufacturer of the instrument is the issuer and the obligation also applies to foreign issuers. The manufacturer may assign the preparation to qualified third parties (according to article 60 (2) FinSA, the Federal Council can designate qualified third parties to whom the preparation can be assigned). However, manufacturers of financial products will not be able to limit their responsibility by such assignment, as by statute they will remain liable for the completeness and accuracy of the details in the key information document, as well as for compliance with the other duties in connection with the KID.

The manufacturer and not the distributor will have to regularly check the information contained in the KID and revise it in the event of material changes during the term of the financial instrument (article 65 FinSA).

c) Who is responsible for providing the KID and when must it be delivered?

The responsibility for providing the KID is on the financial service provider who makes an offer for the purchase of a financial instrument to a retail investor. An offer is defined as any invitation for the acquisition of a financial instrument that contains sufficient information on the terms of the offer and the financial instrument itself (article 2 (h) FinSA). Contrary to the rules under PRIIPs, execution only transactions concluded at the initiative of a retail client in Switzerland can be entered into without making a KID available. The FinSA does not contain any provision which would exempt the financial service provider from the obligation to make a KID available when an offer to buy a financial instrument is made to an asset manager acting for a retail client in Switzerland.

Whenever the manufacturer of a financial instrument has not prepared a KID, the relevant financial instrument may not be offered to retail clients in Switzerland, neither by a financial service provider in Switzerland nor by a foreign financial intermediary on a cross-border basis. The financial service provider may not itself prepare a KID (except where the financial service provider qualifies as qualified third party according to article 60 (2) FinSA and the manufacturer has assigned to it the preparation of the KID)or provide the relevant key information by any other means. This is likely to result in a considerable reduction of the number of financial instruments which can be offered to retail clients in Switzerland, even with respect to plain vanilla bonds, as in particular foreign manufacturers may not want to expose themselves to Swiss liabilities and sanctions. A partial relief of this situation may come from article 61 (2) FinSA, which provides that documents produced under foreign law, which are equivalent to a KID, can be used. However, only second level legislation will define when a foreign document qualifies as equivalent, although there can be no doubt that a PRIIPs-KID will.

According to article 10 (2) FinSA, the financial service provider will have to make the KID available to its retail clients free of charge prior to subscription or conclusion of the contract. According to the dispatch, the disclosure must be made in good time before concluding a transaction, so that retail clients have enough time to read and understand the KID (dispatch, pages 50 et seq.). In addition to the KID for the financial instrument itself, if the value of a financial instrument is calculated based on the development of one or more other financial instruments and if a KID exists for these instruments, the KID for the underlying must be made available as well (article 10 (3) FinSA; according to the clear wording of the provision, the KID for the underlying must only be made available if it exists, i.e. financial instruments for which no KID exists may be used as underlying of a structured product offered to retail investors in Switzerland).

d) How is the KID to be made available?

In contrast to the relevant obligations under PRIIPs, the manufacturers of financial instruments offered to retail investors in Switzerland will not generally be obliged to publish the KID. A publication is only required for financial instruments which are publicly offered in Switzerland (article 69 (1) FinSA), and even in this case, the publication does not need to be on the manufacturer’s website. Based on relevant statements in the dispatch, the author believes that the Swiss government will not impose an obligation to hand out a KID in paper form, but that it will suffice to inform the retail client on what website the KID can be viewed (dispatch, pages 50 et seq.). The KID does not need to be filed for review to the Swiss reviewing body or to the regulator, not even if the relevant financial instrument is publicly offered.

e) What information must the KID contain?

Article 63 FinSA reads very similar to the current provision relating to the simplified prospectus for structured products. The KID shall contain the essential information for making a well-founded investment decision and a comparison of different financial instruments by investors and shall be easy to understand. In particular, the information shall cover (a) the name of the financial instrument and the identity of the producer, (b) the type and characteristics of the financial instrument, (c) the risk/return profile of the financial instrument, specifying the maximum loss the investor could incur on the invested capital, (d) the costs of the financial instrument, (e) the minimum holding period and the tradability of the financial instrument, and (f) information on the authorizations and approvals associated with the financial instrument.

All further details on content, language and layout will be specified by the Swiss government in the ordinance (article 66 FinSA). In order to achieve the goal of making KIDs for different financial instruments comparable, it is believed that detailed regulations will be imposed on matters like risk/return profile or costs disclosure. It is to be hoped, though, that the requirements will not be as complicated and its implementation not as costly as is feared for the PRIIPs regulation. The government should give manufacturers more discretion and flexibility as to the content of the KID than the EU regulators. Given the vast array of financial instruments that are caught by the KID obligation, it is more than questionable whether standardization of disclosure across products can be achieved in any meaningful way.

f) Liability and Sanctions

Where information that is inaccurate, misleading or that in violation of statutory requirements is given or disseminated in a KID, any person involved is liable to the acquirer of a financial instrument for the resultant losses, unless they can prove that they were not at fault (article 72 (1) FinSA).

In addition to this very comprehensive liability provision, the draft law will introduce sanctions for any person who wilfully provides false information or withholds material facts in the KID or fails to publish the KID by the beginning of the public offer (fine not exceeding CHF 500,000 (article 93 (1) FinSA)) and on any person who wilfully fails to make the KID available prior to subscription or conclusion of the contract (fine not exceeding CHF 100,000 (article 93 (2) FinSA)).

3) When will the KID obligation enter into force?

The Swiss Parliament is expected to deal with the FinSA in 2016. Considering the opposition from various industries, it is likely that the Parliament will take more than one year and possibly several years to release the bill. Thus, the FinSA is unlikely to come into force prior to 2018.

However, in the current draft a transition period of two years only applies to financial instruments that were offered to retail clients before the entry into force of the FinSA. For all other financial instruments the KID will have to be ready and available as of the date the FinSA comes into force. Thus, manufacturers and distributors are well advised to familiarize with the new requirements in time in order to be ready when the FinSA comes into force.

Enrico Friz (enrico.friz@walderwyss.com)