The European Supervisory Authorities (ESAs) technical discussion paper has two parts – one dealing with risk and reward (which covers the risk indicator and performance scenarios), and the other with costs.
Three types of risk are considered – market, credit and liquidity. The ESAs are consulting on four approaches to risk disclosure, which are a mixture of qualitative and quantitative measures. None of the approaches covers liquidity risk. The ESAs suggest that the liquidity profile of a packaged retail investment and insurance-based investment products (PRIIP) may be disconnected from the liquidity of the underlying assets. The liquidity profile refers to characteristics of the product itself and should be disclosed in the section of the KID entitled “what is this product”.
A further four approaches are considered for the representation of performance scenarios, ranging from “let the manufacturer decide”, to specific scenarios being prescribed, or an approach based on outcome probabilities, or a combination of the last two.
The cost section starts with a discussion on the different types of costs and charges that can be identified for different types of PRIIPs. As is common in such discussions, the costs and charges within the balance sheet products of banks and insurance companies prove more difficult to identify and quantify, with the consequence that more attention is once more paid to investment funds (both open and closed-ended).
For funds, the list of costs takes much from the current Undertakings for Collective Investments in Transferable Securities (UCITS) regulation but with further consideration of underlying transaction costs and performance fees. For insurance products, there is a separate technical annex on how to quantify the costs of biometric premium embedded in the products. For structured products, the contention is that most costs are included in the price of the product and that therefore an estimate of fair value is required in order to estimate the costs.
The PRIIP key information document (KID) Regulation also requires that the various costs and charges be shown in aggregate form, in both monetary and percentage terms, and on a forward-looking basis.
Two possible approaches are considered – reduction in yield (RIY) and total cost ratio (TCR). RIY seeks to express the overall impact of costs in terms of negative impact on the product’s gross notional return. TCR aggregates the costs of operating the PRIIP and presents them as an annual percentage rate.
With either approach, the forward-looking requirement means that assumptions must be made on growth rates and the interaction with the reward section of the KID has to be considered.
The paper raises wider questions about the intention of the PRIIP KID is at risk of being lost in such technical debates. The approaches will all lead to disclosures that are based on assumptions on assumptions (such as likely market returns), rather than historic or known facts. The discussion also highlights the very different nature of different types of PRIIPs and the risk that one of its key objectives will be missed: to provide accessible and readily understandable information to enable consumers to make comparisons between products of the same type and of different types.
The ESAs intend to issue in the autumn a final consultation paper with draft rules. The rules, which will take the form of regulatory technical standards, must be finalized and submitted to the European Commission for adoption by 31 March 2016.
Given that the PRIIP KID must be implemented by January 2017, it is essential that firms start their internal processes now in order to stand any chance of having the KID designed and systems in place and tested by January 2017. Firms should also pay close attention to the rules in Markets in Financial Instruments Directive (MiFID) II on the disclosure of costs and charges, which are inter-related.