The European Supervisory Authorities (the ESAs) have submitted to the Commission the final Regulatory Technical Standards (RTSs) on the PRIIP KID (Packaged Retail Investment and Insurance-based Products, Key Information Document), which must be implemented by the end of this year for all PRIIPs sold – directly or indirectly – to retail investors.
Some aspects of the rules are new or significantly revised from the draft and further guidance is still to be issued, but officials continue to resist calls for a change to the implementation date to align with that proposed for the Markets in Financial Instruments Directive II (MiFID II). PRIIPs include a wide range of banking and insurance products and alternative investment funds (AIFs). Moreover, the rules effectively require UCITS offered as the underlying investments of e.g. unit-linked products to produce the PRIIP KID, despite the explicit exemption in the Regulation. The presentations and underlying methodologies of the risk, performance and costs sections are causing considerable concern within the industry and with consumer groups, for different reasons. The complex rules and tight timeframe make this a challenging operational and client-facing exercise for all types of firms.
PRIIPs include structured deposits and products, some securities, derivatives, contracts for difference SPVs, unit-linked and with-profits insurance products and alternative investment funds (AIFs). There is a temporary exemption for UCITS but many will be caught indirectly where they are the underlying investment of a “multiple option” PRIIP (see below).
The draft RTSs prescribe the KID template and the presentations and underlying methodologies of the risk, performance and costs sections. They include specific rules for exchange-traded derivatives (new), multi-asset products (new) and “multiple option” PRIIPs (e.g. unit-linked insurance contracts with options for the underlying investments) and on the provision and review of the KID.
The ESAs’ task was a difficult one given the very different nature of different types of PRIIPs. Also, unlike the UCITS KIID, whose disclosures on risk, performance and costs are based on historical data and known future charges, the PRIIP KID disclosures are forward-looking. This requires assumptions to be made about future market returns, possible product performance, the expected volume of underlying transactions in funds and the future profit participation and take-up of biometric risk options in insurance products.
The industry and consumer groups are concerned that the original intentions of the PRIIP KID have been lost amid technical debates. It has led to disclosures that are based on assumptions on assumptions, rather than historic or known facts and one of the key objectives – to provide accessible and readily understandable information to enable consumers to make comparisons between products of the same type and of different types – risks being missed.
A new provision has been introduced that requires the KID to be revised if annualized performance changes by more than 5 percent, which could lead to regular revisions in protracted volatile markets.
For market risk, the text is now much clearer but issues remain. The proposed five categories have been reduced to four. Structured deposits and capital protected products are no longer automatically in Category 1. PRIIPs with illiquid underlying assets or which deal less frequently or for which market or historical data is not available are now in Category 1. Funds still appear to fall into three categories.
For Categories 2 and 3, the table that translates VaR results into the seven-point scale has been amended. Firms that did some initially testing of the methodology will find that the results are now significantly different.
A credit risk figure must be calculated when the return of the investment depends on the creditworthiness of the manufacturer or another party bound directly or indirectly to pay the investor. This would imply that e.g. funds do not have to calculate credit risk, but a different provision says that they need to look through to the underlying assets. The calculation is based on external credit ratings, but the simplistic conversion table has been replaced with reference to the Implementing Regulation of the Solvency II Directive, with prescribed adjustments. There appears to be a difference in the treatment of EU versus non-EU rated assets.
Three performance scenarios must be shown – labelled unfavorable, moderate and favorable – and are now prescribed as the 10th, 50th and 90th percentiles, using a similar calculation to that for market risk, net of costs. For insurance products, assumptions must be made about future profit participation and the cost of biometric risk cover, for which a fourth performance scenario must be provided. Graphs have been replaced with a simple table with monetary and percentage figures for three time points, because consumer testing showed that investors do not understand graphs. However, a graph has been introduced for exchange-traded derivatives.
The costs section includes specific provisions for investment funds (the most extensive), insurance products (which include biometric risk premiums) and other PRIIPs. The two tabular presentation remains, but has been simplified to show “cost over time” and “composition of costs”. Costs are expressed in monetary and percentage terms based on an investment of €10,000 for all PRIIPs and showing the effect on return by “Reduction in Yield”. For funds, the proposed calculation for underlying transaction costs continues to cause concern as it is based on so-called “arrival” prices, which do not exist in some markets.
Multiple Option PRIIPs (MOPs) can follow one of two approaches: a separate KID for each option or a generic KID for the MOP with separate information about each option. The rules require UCITS offered as the underlying investments of e.g. unit-linked products to produce the PRIIP KID, despite the explicit exemption in the Regulation.
The rules have been submitted to the European Commission for adoption, but additional guidance and FAQs are to be issued. The PRIIP KID must be implemented by the end of this year, so 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 in time.
Firms should also pay close attention to the rules in MiFID II on the disclosure of costs and charges, which are inter-related and being developed to a different timeframe.