New disclosure document poses significant challenges for funds

New disclosure document poses challenges

Don’t be fooled by the supposed exemption for UCITS in the PRIIP KID¹ Regulation. Most UCITS, together with retail Alternative Investment Funds (AIFs) that currently provide the UCITS KIID, must provide PRIIP KID information by the end of this year. Distributors' obligations under MiFID II and requirements for banks and insurers PRIIPs with funds as the underlying investments make the exemption meaningless in many cases.

Director, Investment Management, Regulatory Change

KPMG in the UK

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Don’t be fooled by the supposed exemption for UCITS in the PRIIP KID¹ Regulation. Most UCITS, together with retail Alternative Investment Funds (AIFs) that currently provide the UCITS KIID, must provide PRIIP KID information by the end of this year. Distributors' obligations under MiFID II and requirements for banks and insurers PRIIPs with funds as the underlying investments make the exemption meaningless in many cases.

Moreover, the underlying methodologies for the PRIIP KID for risk, performance and costs are very different to those in the UCITS KIID. With only seven months to go, and with other major regulatory implementation projects underway, fund managers need to start now.

The scope of PRIIPs is wide and includes structured deposits and products, some securities, derivatives, contracts for difference, SPVs, unit-linked and with-profits insurance products, and AIFs. There is a temporary exemption for UCITS until after the review in 2019, but many will be caught indirectly where they are the underlying investment of a 'multiple option' PRIIP (eg unit-linked and with-profit insurance contracts or banking products with which investors have different options for the underlying investments). Also, under MiFID II, fund distributors will need to ask fund managers for costs and charges information in line with the PRIIP KID.

The rules prescribe the KID template, the presentations and underlying methodologies of the risk, performance and costs sections, and the provision and review of the KID. They include specific rules for multi-asset funds and funds of funds. 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 and the expected volume of underlying transactions in funds.

For market risk, a fund may fall into one of three categories, each with a different calculation. And it seems that some funds may need to calculate underlying credit risk.

The presentation and underlying methodology of the costs section, in particular, is causing considerable concern within the funds industry and with consumer groups. Two tables show ‘cost over time’ and ‘composition of costs’. Costs are expressed in monetary and percentage terms based on an investment of €10,000 and showing the effect on return by 'Reduction in Yield'.

However, actual entry, ongoing and exit costs and charges are not shown, only the RIY. This means that investors will not see clearly that there is a 5% initial charge, for example. Also, the proposed calculation for underlying transaction costs continues to cause concern. It is based on 'arrival' prices, which do not exist in some markets, or on opening prices, which could lead to negative transaction costs being disclosed.

Next steps

The rules have been submitted by the European Supervisory Authorities (the ESAs) to the European Commission for adoption. We understand that MEPs and the Commission continue to resist calls for the deadline to be extended because they are concerned that any delay will be seen as an opportunity to lobby for changes to the rules that will weaken the disclosures. The Commission is expected to adopt the rules by July.

There are a number of issues with and questions about the draft rules. Regulators recognize this, and the ESAs propose to provide some clarifications via Level 3 guidance and/or Level 4 FAQs, on which they are already working.

Given this, firms need to work on the basis that the PRIIP KID must be implemented by the end of this year. 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.

Critical questions for firms to address

Which of your UCITS and AIF will need to provide PRIIP KID type information on risk, performance and costs & charges?

Have you considered the underlying methodologies and worked out which ones apply to which funds?

How will you source the data needed to make the calculations?

If you are considering outsourcing, what governance structure will you put in place, including ensuring you have sufficient technical experience in-house to be able to monitor your chosen provider effectively?

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