The Packaged Retail Investment and Insurance Products (PRIIPs) regulation has long been one of the most controversial and contentious regulations in E.U. legislative history. Normally, such tensions result in an industry versus regulator standoff, but in the case of PRIIPs, even the European regulators, bureaucrats and politicians remain at loggerheads.
Up until recently, PRIIPs had been put on the backburner as UCITS managers turned their thoughts to other pressing matters such as SFDR implementation, ESMA focus on fund liquidity, and the ever increasing focus on operational resiliency. However, PRIIPs is once more in the headlines because of a pending deadline for application of the regulation to UCITS funds.
There have always been two primary issues which have resulted in these perennial PRIIPs conflicts:
- PRIIPs attempts to apply standardized calculations and disclosures on insurance, banking, structured products, and funds and assumes these product types are relatively homogenous. They are not.
- All revisions have been made on an ongoing basis with tweaks to regulatory technical standards (RTS) but avoiding a total Level 1 rule rewrite. PRIIPs 2 is the only way to fix the fundamental disconnects.
The Good News
UCITS have enjoyed an exemption from production of PRIIPs KIDs for some time now. The exemption was due to expire on December 31, 2021, despite the protestations of industry. It has been reported that the European Commission heard the industry’s concerns regarding concerns of applying the new standards to UCITS and is willing to grant some relief. It is expected that the UCITS exemption for PRIIPS KIDs will be extended for six months, making the compliance deadline July 2022. This still needs to be confirmed and then further approved but it is some respite to UCITS funds, as they grapple with transition requirements to the new KID format.
The additional time is helpful since there are several key changes to be implemented by UCITS, driven by differences to the existing UCITS Key Investor Information Document (UCITS KIID) and the PRIIPs Key Information Document (PRIIPs KID).
Even the short extension is complicated to execute, since it requires a “quick fix” and fast-tracked, targeted revision to the core UCITS Directive to avoid a situation where UCITS might be required to publish both a PRIIPs KID and UCITS KIID at the same time. This necessitates some prompt legislative approvals through the E.U. Commission, Council, and Parliament to ensure duplicative disclosure documents will not coexist at the same time for UCITS investors.
The European Supervisory Authorities (ESAs) had originally rejected the Commissions’ PRIIPs regulatory technical standards (RTS) but have now been convinced that simply approving them is the “least worst option.” Also, the approval of the RTS is predicated on assurances from the European Commission that the comprehensive review of the PRIIPS regime planned for 2022 will proceed, and look to address the fundamental issues which have dogged PRIIPs since its inception. In particular, the ESAs have asked for commitment to align PRIIPs to a much greater extent with the parameters of MIFID and the Insurance Distribution Directive (IDD) for example.
There is also a commitment to provide investors with a “digitized KID” and further move away from paper-based investor documentation. Commitment to future improvements is helpful, and it is positive that the E.U. policymakers formally acknowledge change is required. Interestingly, the E.U. recently launched its consultation on its “Retail Investment Strategy for the E.U.” which focuses on both UCITS and PRIIPS as central to the pan to have E.U. investors invest more in non-bank products. For that reason alone, PRIIPs is important as it is intended to be the primary information document for retail investors across Europe, as such industry contends that it ought to be “fit for purpose”.
While commitment to future improvements is helpful, there are still a number of challenges in the more immediate future.
The Not So Good News
So, the extension of the exemption is unquestionably a positive, however, it doesn’t alleviate the very obvious technical challenges UCITS funds retain as a result of a sub-optimal ruleset. And even with the deadline extension, transition to the new form of PRIIPS KID for UCITS is going to be challenging operationally because the industry collectively has been frozen by uncertainty. Thus, many managers have not yet begun planning for the technical revisions required.
As managers plan for the transition, they will note some targeted revisions and accommodations have been made to the PRIIPS methodologies, however, the areas of most contention remain, namely:
- The use of future performance scenario
- Use of Reduction in Yield (RIY) rather than actual costs
- Use of slippage and arrival prices in cost calculations
Five pain points remaining within the PRIIPS KID process are outlined below:
1. Performance Disclosures
One of the biggest concerns of applying the PRIIPS standards to UCITS funds relates to the provision of future estimated fund returns rather than the tried-and-trusted historical fund performance. PRIIPs requires a UCITS to estimate the funds’ future performance under four prescribed market scenarios:
UCITS will calculate portfolio returns on rolling 10-year basis with the lowest value representing the “unfavorable” scenario, the median of returns representing the “moderate,” and the highest calculated returns being the “favorable.” The stress scenario remains same as before. Regardless of the technical methodology, UCITS managers remain more concerned with the fundamental principal of extrapolating returns into the future, which is a far less certain than the traditional disclosure of past performance and caveat that “past performance is no guarantee of future results.”
In another pragmatic concession, UCITS will be allowed to make certain adjustments to the calculated returns, if they consider the results will provide investors with “inappropriate expectations about the possible returns they may receive.” This is recognition that UCITS do not operate identically to structured products and that the past is not always a reliable predicator of the future. UCITS will also be authorized to provide a link in the “Other relevant information” section of the PRIIPS KID guiding investors to another website or separate document showing past performance (in a manner currently shown in existing UCITS KIIDs such as a bar chart with historic annual return for past 10 years).
These accommodations are useful in that they allow latitude to calibrate the information in a more suitable fashion for UCITS. However, at the same time, granting these exemptions, is tacit acknowledgement of the limitations of the existing PRIIPS performance calculations and that future performance methodologies are sub-optimal.
2. Reduction of Yield Disclosures
PRIIPs KID show investors product costs in two ways: Reduction in Yield and a tabulated list of all cost components. There have been some targeted changes to the RIY calculation methodology. While the RIY is maintained for UCITS, the assumed holding period is one year and should assume a 0% return. This revision recalibrates the calculation to be aligned with the MIFID 2 requirement. The list of product costs will now also include additional explanation of what each of the costs are, as investors feedback suggested that investors were not sure what each line item was.
3. Implicit transaction cost estimation
Another long-time bugbear of PRIIPs industry commentators relates to slippage cost methodologies. Regulators maintain that the impact of market movements on slippage costs invariably even out through netting. However, data evidence suggests they do not. The impact of market movements and use of arrival prices for slippage cost calculation often leads to a scenario where transaction costs are negative (fund made money from making transactions). The PRIIPs RTS maintain that “slippage is more accurate representation than bid-ask spread.” Most bond traders in particular disagree but the revisions do make some accommodation and introduce a specific exemption to the use of slippage for OTC trades or where transaction volumes are so low that aggregation doesn’t eliminate market movement.
4. Brexit Wrinkle
Another peculiarity for UCITS funds lies in the fact that although the E.U. is making targeted revisions to ensure UCITS do not have to provide both legacy UCITS KIIDs and the new PRIIPS KID, in the United Kingdom the situation is less clear. As we have flagged before, with Brexit you know have two types of “UCITS” in the U.K. market. Those E.U. UCITS who continue to passport into the U.K. market through temporary passporting regimes and will move to an Offshore Fund Regime in time, and legacy U.K. funds who were under the UCITS regime and who have retained that moniker post Brexit.
The U.K. HM Treasury’s recent policy statement extended the UCITS PRIIPs exemption until 2026. In the interim, the U.K. will want to frame a more appropriate domestic successor to the UCITS KIID and they have pointed to improving the presentation of performance for example already. However, in the interim, you may need to produce a U.K. specific UCITS KIID (modelled on existing UCITS KIID regime) on top of the generic PRIIPs KID for E.U. markets.
5. Technical Specifications
PRIIPS KID production is not easy. The recent EFAMA statement outlines in detail the importance but also the complexity of PRIIPS KID production. A decent-sized asset manager distributing in various markets can produce thousands of KIDs for their product range. Competing priorities and the ongoing impact of remote working environment is also adding to the complexity of the PRIIPs transition projects. The new calculations and methodologies require new data feeds and testing before they can be deployed for crucial retail investor disclosure documents. Their production involves multiple participants from the product manufacturer, third party data specialists, and right the way through the various distribution channels. Current PRIIPS KIDs can require up to 100 unique data points currently and sourcing reliable data is critical. Some E.U. member states require preapproval of any retail investor disclosure documents by the national regulator so this must also be factored into the deadline.
In summary, the race to revise PRIIPs KIDs is already on. While PRIIPS 2 and a fundamental overhaul seems likely on the horizon, grappling with the shorter-term transition from tradition UCITS KIID to revised PRIIPS KID is the more concrete short-term goal.
Should you wish to discuss any of the technical requirements in further detail, please do get in touch.