Spain mandates disclosure of a risk indicator and liquidity and complexity warnings in certain financial products

The Ministerial Order ECC/2316/2015 of 4 November regarding disclosure and classification obligations on financial instruments was published on 5 November 2015 in the Spanish Official Gazette (BOE) (the Order). 

Background regulation and soft law 

Until publication of the Order, the rules on the marketing of complex products were mainly contained in two sets of guidelines issued by the Spanish securities market regulator (the CNMV): 

• The "Guide on the categorisation of financial instruments as complex or non-complex products" published in 2010 and based on ESMA's "Q&A MiFID complex and non-complex financial instruments for the purposes of the Directive's appropriateness requirements" published by ESMA (formerly known as CESR) on 3 November 2009.
• The "Guide on marketing of complex products" published in April 2014 and which is based on ESMA's Opinion Documents dated 7 February 2014 (the "MiFID practices for firms selling complex products") and 27 March 2014 (the "Structured Retail Products – Good practices for product governance arrangements").

In 2014, the CNMV published a draft circular¹ providing "soft law" guidelines and general provisions under the Spanish Securities and Markets Act (the LMV) relating to the precise information to be given when marketing financial products. 

The contents of the Order 

What financial products are covered?
The Order covers: (a) financial instruments (under article 2 of the LMV, which will include, among others, listed shares and bonds); (b) bank deposits; (c) life insurance products; and (d) pension funds (jointly, the Products). However, the Order does not apply to Products which are already covered under the PRIIPs KID requirement (so, for example, structured products are excluded) and there are certain other exemptions.²

Objective of the Order: what does it do?
The aim of the Order is to offer better protection to investors in Products by prescribing standardised information and classification requirements to highlight the riskiness of the relevant Product and to enable investors to identify the risk embedded in a Product. 

With this aim in mind, the Order requires financial entities to provide investors with the following information: 

• a risk indicator; and
• where applicable, liquidity and complexity alerts

Who needs to do this?
All entities marketing Products, including both Spanish and foreign financial entities marketing Products in Spain. 

The issuers of Products are also subject to the information and classification obligations when they provide investment services regarding Products (NB: merely issuing a Product will not trigger the requirement). 

Firms are required to implement the new rules within three months.

For which clients?
This Order applies only to non-professional (i.e. retail) clients; the provision of investment services or the marketing of Products to professional clients³ is not covered by the Order. 

The marketing of Products to a client under a portfolio discretionary management service is also excluded, since the relevant entity would be taking the investment decision for the account of the client. 

What needs to be done?
Anyone marketing or providing investment services in relation to Products must include certain information in the promotional and other pre-contractual materials for the marketing of Products. 

The Order seeks to standardise the written information that is provided to clients when marketing a Product under MiFID. It does not alter the obligations under MiFID, but prescribes the form in which they should be complied with under MiFID. The idea is that a common form will make it easier for clients to compare the information and that a standardised, less complex language will help them to understand the relevant Product and its related risks. 

In essence, the information to be provided to clients must include: (i) a risk indicator (Risk Indicator); and (ii) provided that if certain conditions are met, certain liquidity and complexity warnings (Liquidity and Complexity Warnings). 

• Risk Indicator
  This is the classification of each Product according to its risk. 

  The Order contains an Annex including pro-forma charts and colours which are to be used to identify the applicable Risk Indicator. There are also very specific instructions regarding the form and placement of the Risk Indicator in the document(s) provided to clients. 

  There are six classes of risk ranging from level 1 (less risk) to level 6 (highest risk): 

  • Class 1: bank deposits and saving insurance products;
  • Class 2: non-subordinated financial instruments denominated in euros which include a 100 per cent recovery provision on the principal investment over a term of three years or less. 
  • Class 3: non-subordinated financial instruments denominated in euros which include a 100 per cent recovery provision on the principal investment over a term of more than three years and less than fice.
  • Class 4: non-subordinated financial instruments denominated in euros which include a 100 per cent recovery provision on the principal investment over a term of more than five years and less than ten. 
  • Class 5: (a) non-subordinated financial instruments denominated in euros which include a 100 per cent recovery provision on the principal investment over a term of more than ten years.  (b) non-subordinated financial instruments denominated in euros which include at least a 90 per cent recovery provision on the principal investment over a term of three years or less 
  • Class 6: Any other Products not included in any of the five classes above. 

For a Product to be rated as Class 1 or Class 2, one of the Product, its issuer or its guarantor will need to have a level 1 credit rating. A Level 2 credit rating for one of the Product, its issuer or its guarantor, will suffice for the other classes. 

• Liquidity and Complexity Warnings 
  

  Liquidity and Complexity Warnings are only required if certain conditions are met. If so required, they must be included in marketing materials and pre-contractual information required under MiFID.

  The Liquidity and Complexity Warnings are also prescribed in the Order. 

  • Liquidity warning
    A liquidity warning will have to be included when the liquidity of a Product is limited or restricted in any manner. 

    For example, if a Product is capital-protected – either totally or partially – the materials must expressly state what percentage of the investment is capital-protected and warn whether this will only be returned at maturity and disclose any penalty to be paid or losses that may be incurred in the event of early termination.

    If early termination is not possible, or where early termination may carry a penalty or imply a loss, this also needs to be expressly stated. Warnings must also be included in relation to commissions, penalties and prior notices for liquidation as well as if the liquidity of the Product is linked to market developments and there is a possibility of incurring significant losses. 

    The Annex to the Order sets out a number of scenarios of liquidity restrictions and the specific wording applicable to each scenario. If a Product includes any of the above liquidity limitations or restrictions, the applicable liquidity wording must be inserted. 

  • Complexity warning
    The following warning must be inserted for complex products: "This financial product is not simple and it may be difficult to understand"

    The Order defines complex products as those products which are defined as complex under the LMV⁵ (such as non-capital protected or illiquid products) and by the Bank of Spain, the CNMV or the Dirección general de Seguros y Fondos de Pensiones (General Directorate of Insurance and Pensions).

    The Order will enter into force three months after its publication in the Spanish Official Gazette. 

<sub>Notes
1. The Order contains some of the main provisions foreseen by the Draft Circular but it aims to tackle not only financial instruments (as defined by article 2 of the Spanish Securities Markets Act) but all sorts of investment and saving products and services which are made available to retail clients by banking entities or insurance companies (including deposits, life insurance products and pension funds).
2. The Order expressly excludes its application to:</sub>

• _{Instruments covered by the European Regulation on key information documents for packaged retail and insurancebased investment products (PRIIPs);}
• _{Public debt;}
• _{Group insurance contracts covering pension obligations, company insurance schemes, insurance policies entered into by pension plans to cover risks and plan benefits and all type of life insurance contracts set out in article 3 of Order ECC/2329/2014 of 12 December; and}
• _{Collective investment schemes.}