PRIIPs – What can we take away from the last Joint Consultation Paper?

  • From its entry into force, PRIIPs faced many criticisms from market players and representatives of Financial Services Users about pro-cyclical performance scenarios, misleading costs & charges disclosures, non-adequate transaction costs monitoring…
  • Due to open questions and operational workload to comply with the regulation on due time, the implementation of PRIIPs for UCITS funds was delayed from January 2020 to January 2022
  • A first consultation paper released in November 2018 was focused on a limited set of topics (performance scenarios, costs & charges mainly)
  • On October 16th, the ESAs released a new consultation paper on PRIIPs KID after years of lobbying and discussions about PRIIPs’ flaws
  • The new consultation is a quite technical and detailed piece of work aiming at answering main concerns from the Industry and representatives of Financial Services Users
  • Surprisingly, many options are explored by the ESAs with nothing set in stone on core topics, letting room for lobbying from the Industry
  • A review of Level 1 text is needed to validate some changes, as underlined by the ESAs

In the following document, we explore for each topic of the consultation paper proposals from the ESAs and opportunities/threats for the Industry

1. Performance scenario computation & illustration

Evolution and proposals:

  • Though the initial model for future performance was simple and easy to compare for end investors, ESAs acknowledged its pro-cyclical and the need for a change.
  • ESAs propose now to replace the observed historic growth by the growth rate per asset (reference rate + premium) calculated from the dividend yield. Successful but partial (not all types of PRIIPS) testing has been done. Premium based on dividend yield is a proxy not able to catch the full performance of an underlying (75%) and that may be misleading in some market conditions (high dividend yield during market crash as in 2008)
  • ESA acknowledge the need for simplification and consider the option to remove the moderate and stress scenarios.
  • The calculation of future performance (Cornish-Fisher, Monte Carlo,…) are impacted by the proposal to use the dividend yield.

Impact assessment:

  • Impacts are wide and for all actors, though Asset Managers in the obligation to prepare for a Go Live in 2022 must choose a direction and manage the uncertainty.
  • The comparability between products and manufacturers is essential, the complexity and the wideness of options still opened must be reduced to minimize the impacts and enable end user to understand the numbers provided. Decomposition per country and sector seems unrealistic technically and source of debates.
  • The calculation, the data gathering are complex to implement and maintain. Costly expertise and technology are required.
  • With the concept of reduction of yield, the healthy objective to simplify and reduce the number of scenario might not feasible on moderate scenario and stress scenario is probably one of the most interesting scenario to keep.
  • The communication of these scenarios via the EPT is ok but challenging via the KID to remain readable and within 3pages.

Our opinion:

  • After years of discussions, ESA must now set the methodology to follow and keep it simple and no space for interpretation to keep comparability.
  • Dividend yield methodology is not a good solution as it will quickly be ignored by end customers as soon as they will understand the limits (never granular enough, not differentiating AMs,…)
  • Past performance with a stressed scenario would be more meaningful for end customers.
    In this context, it is key to start gathering data and prepare risk systems for such calculations, clarity will likely be short notice…
  • Extension of the historical period used for the calculation has been ignored, though not perfect it was going in a position direction.

2. Past performance: regulators open the door for past performance disclosure for funds only

Evolution and proposals:

  • The inclusion of past performances is assessed for Category 2 products (funds) only and not for other PRIIPs such as investment bank or insurance-based products. Two options are proposed by ESAs:
    • A reuse of current UCITS past performance disclosure with bar charts
    • The disclosure of average performance even if this option is not tested in the European Commission
  • ESAs do not want to replace performance scenario by past performances. Performance scenario are here to stay
  • Regarding insurance-based products, ESAs open the door for past performance disclosure a proper methodology is needed
  • Additional disclaimers may be added to explain for instance the link between past/prospective performance

Impact assessment:

  • Impacts are focused on Asset Management products, no impact on other PRIIPs (past performance integration is not assessed)
  • Integration of past performances is a game changer for clients but should not be complex to implement for Asset Managers, if the reuse of current UCITS disclosure methodology is confirmed
  • The adaptation of KID template and the ability to release a clean 3-pagers document will have a major impact on KID production
  • Clear disclaimers will be key to make sure client understand what is behind past performance and the link with performance scenarios

Our opinion:

  • After years of lobbying, ESAs open the door for a most needed adaptation, key to ensure proper understanding by clients
  • The reuse of current UCITS approach seems simpler and clearer than average performances that may be misleading
  • The integration of past performance in a 3-pagers will be a major challenge to keep the KID clear

3. Costs & charges – Summary tables and KID layout

Evolution and proposals:

  • ESAs proposed 4 options to disclose costs and summary costs indicators in the KID and identified one preferred approach:
    • Retain the RIY, arguing that it is the most pertinent cost indicator allowing fair and meaningful comparison between products
    • Clearly separate the RIY and total monetary cost figures
    • Include a specific description of different costs and how they are calculated
  • Moreover, ESAs listed some proposals for which they expect stakeholders’ feedback:
    • Fix intermediate time period instead of current half RHP: fix intermediate time period at 5 years if RHP>8/10 years? Or fix time period at 10 years if RHP>15years?
    • Disclose an annual average cost figure at RHP or include a total (accumulated) monetary cost?
    • Include a total cost as a percentage of the investment amount?

Impact assessment:

  • The preferred approach for costs presentation is the most complete and detailed one. It requires to set up a more complex and detailed costs computation mechanism at different time periods, taking into account performance scenario (for RIY calculation)
  • This new approach provides a clear split between the two indicators (RIY and total cost)
  • The manufacturers should provide more transparency on the breakdown of costs and assumptions for calculation

Our opinion:

  • Adding descriptions and details of different costs component will provide more transparency for both investors and sellers/advisors
  • RIY methodology could lead to misunderstanding as it requires to make several assumptions on expected return, investors are not used to this indicator
  • Showing costs at different time periods could be overload of information for the investor
  • The interest to keep monetary cost estimates could be challenged

4. Costs & charges – Zoom on transaction costs computation

Evolution and proposals:

  • ESAs maintain that it is very relevant to provide more transparency on implicit transaction costs arguing that it should promote effective competition within the market and manufacturers should focus on investors’ best interests and minimize the costs. They introduce two options:
  • Option 1 amending the arrival price methodology:
    • Adjust the slippage methodology depending on the type of asset, in particular OTC transactions and those involving non-financial or real assets by introducing a proportionality threshold allowing the use of a simplified approach where there is a low number of transaction or a low turnover
    • ESAs recognize that negative transaction costs could be misunderstood and confusing and intend to adjust the rules so that negative transaction costs can never be disclosed
  • Option 2 replacing the arrival price methodology:
    • Replace the arrival price methodology by a more principles or criteria based approach to better reflect the characteristics of the specific trades and avoid risk of inappropriate results (e.g. size of order, liquidity of the instrument, mode of negotiation…)
  • At this stage ESAs see more merit in option 1

Impact assessment:

  • Option 1: the arrival price methodology raises the significant practical challenges relating to data collection
  • Option 2: complex methodology with more uncertainty on how to apply the criteria in practice
  • The two options are complex and expensive to implement, as they require extensive operational procedure and controls

Our opinion:

  • Option 1, the arrival price methodology, considers that market movements are costs paid by the client which is not in line with MIFID II Directive as it mostly capture a measure of the best execution of a trade
  • Option 2 could lead to a material risk of inconsistent applications between manufacturers
  • Both methodologies are expensive and complex to implement
  • The methodology based on a standard grid of spreads results in more realistic figures that are not misleading for the retail investor. Nevertheless, this methodology is still not favoured by the regulator

5. Expected amendment before the end of UCITS exemption

Evolution and proposals:

  • Before taking any decision on the potential expiry of the UCITS exemption, ESAs addressed the parts of UCITS Regulation to be included or not in the PRIIPs Regulation. Potential issues have arisen from the comparison between the two Regulations:
    • PRIIPs regulation is intended to retail investors only while UCITS regulation is also applicable to professional investors. ESAs propose, in the absence of change in the UCITS Directive, to provide a PRIIPs KID to retail investors and a UCITS KII to Professional investors
    • ESAs raise differences in the document delivery requirements of the UCITS and PRIIPS regulations for regular saving plans: as of today, a new UCITS KII has to be delivered in case of change in subscriptions while a new PRIIPs KID has to be delivered each time the KID is revised (i.e. change in costs and charges, risk indicator…)
    • Also, ESAs wondered whether some requirements under UCITS Directive should be restricted to Management Company of UCITS and AIF or extended to all types of PRIIPs 

Impact assessment:

  • Potential coexistence of two documents under two different regulations (the UCITS KII for professional investors and PRIIPs KID for retail investors for a same UCITS)
  • Amendments are expected to be done on both Regulations to avoid coexistence of two documents
  • Growing complexity linked to the number of information and documents to be produced depending on the type of product

Our opinion:

  • Coexistence of two docs. could lead to a lack of clarity and misunderstanding of requirements and would be confusing given the different way the same type of information are presented in each document
  • Need to have one single document. Professional investors should receive a (simplified) PRIIPs KID
  • Amendments should be done on both Regulations to align the requirements and avoid the coexistence of two documents

6. Generic KID new approach for Multiple Options Products (MOPs)

Evolution and proposals:

  • ESAs explain that if the UCITS KII is replaced by the PRIIPs KID starting from 2022, then the information on underlying options should be provided on a comparable basis using the PRIIPs KID
  • ESAs propose to introduce different approaches depending on the type of options:
    • Provide more complete information on a min of four “most frequently selected” options or combination of options
    • No change for other options
    • This approach will not be required where there is minimal or « linear » costs applied at the level of insurance contract
    • ESAs propose to include a short narrative to highlight whether or not all costs are shown and further specifications on the structure of information to be provided on the specific investment options
    • Considering that wide costs ranges is useless information, one option is to introduce different rows per risk class in the “cost over time” table

Impact assessment:

  • The new approach raise the significant practical challenges to define and update the “most frequently selected“ options or combination of options, specifically for product offering a large number of options
  • This approach causes additional costs for manufacturers to monitor the history of options or combination selected. Could lead to a reduction of number of options proposed by manufacturers
  • Adding information can have negative effects on both understanding and the visual presentation of the KID

Our opinion:

  • Having a generic KID and a similar specific KID for investment options will better enable comparison between the MOPs and contractual options and aggregation of costs to be paid
  • Other non ”most frequently selected” options may never be selected by investors due to a lack of information
  • Misunderstanding risk: the investor may understand that other options are not possible or not profitable
  • Introducing costs per risk is an overload of information that could have negative effect on the clarity of the KID

In a nutshell, this new PRIIPs consultation raises more questions than answers: the road ahead is bumpy for the Industry

  • ESAs are still not mature about most controversial PRIIPs topics with a consultation including a whopping 57 questions
  • ESAs are aware of PRIIPs flaws but adaptations are complex to setup and a review of the level 1 text should be needed to get tangible changes
  • Lobbying on past performance should be successful. Regarding other key Industry’s concerns (performance scenarios, costs & charges disclosures…) current orientations remain complex and would not add clarity and comparability to end customers
  • ESAs should provide more guidance from the end of Q1. It is needed to analyse impacts right away and setup projects. Knowing the complexity of PRIIPs, anticipation is paramount to be ready with robust and automated solution by the end of 2021