This post was written by Jinyan Li, a London-based analyst in Axioma’s Reporting Solutions team. She is primarily responsible for completing periodic filings and servicing clients globally.
The European Commission found that retail investors will often enter into investments without fully comprehending the associated costs and risks. To remedy that, the Packaged Retail and Insurance-based Investment Products Regulation (“PRIIPs”) was introduced on 1st January 2018 to improve EEA retail investors knowledge of PRIIP prior to engaging in a transaction. Now six months later, we take a closer look at how this regulation impacted the market and investors.
What is a PRIIP?
The Packaged Retail and Insurance-based Investment Product is defined as:
“an investment where, regardless of its legal form, the amount repayable to the retail investor is subject to fluctuations because of exposure to reference values or to the performance of one or more assets that are not directly purchased by the retail investor; or an insurance-based investment product which offers a maturity or surrender value that is wholly or partially exposed, directly or indirectly, to market fluctuations.”
(FCA – PRIIPs disclosure: Key Information Documents)
What does the PRIIP Initiative Include?
The Initiative requires all who participate in the marketing and construction of a PRIIP to provide the investors a stand-alone, standardized document for each investment. This Key Information Document (KID) is to be no larger than three sides of A4, entailing a total 81 mandatory fields that aim to provide potential retail investors with insights to the investment’s costs, risks and performances under different scenarios, and other information deemed relevant.
The cost section includes all costs which are incurred in the operation of the PRIIP. The aim is to give investors a clear breakdown of costs when entering into the investment, including entry/exit, recurring/transaction, performance-related, and other one-off costs.
The risk section introduced three new risk measures:
1. Market Risk Measure (MRM) – MRM is calculated based on its benchmark/proxy price over the past five years; in the case that not enough data is available, a shorter period may be used. The VEV value is assigned based on the calculated Variance-equivalent Volatility (VEV) value.
2. Credit Risk Measure (CRM) – CRM is defined by an external credit assessment institutions (ECAI) certified or registered with the European Securities and Markets Authority (ESMA).
3. Summary Risk Measure (SRM) – SRM is allocated based on the combination of MRM and CRM values.
The performance section shows a range of expected returns for the PRIIP under four potential stress scenarios, based on the product’s recommended holding period. The data used to compile KID can mostly be sourced from the fund administrator, using historic data as a guide of expected performance returns.
What does this mean for the PRIIPs manufacturers and advisers?
The implementation of PRIIPs brings about an increase in the amount of information that needs to be processed and reported by the manufacturers and advisers. The KID will need to be updated whenever there are changes to the PRIIP. This requirement places yet another regulatory burden on the increasingly heavy reporting requirement in recent years.
To reduce the time spent and cost related to new regulations such as these, manufacturers and advisers are outsourcing to solution providers. By delegating the work of data management, analytics and compilation of the KID to a specialist provider, the manufacturer and/or advisor can ensure effective and cost-efficient process and timely compliance with the regulator’s requirements.
Criticisms of the PRIIPs KID
It is essential that the PRIIPs KID is an accurate, impartial and informative document which improves the reader’s investment-making decisions. Misrepresentation of the data is a gross violation of the PRIIPs Initiative’s purpose. Critics have identified two points which were deemed counterproductive against its aim to improve transparency and better guide investor’s decisions.
With regards to the calculation methodology, FCA has received criticisms from commentators that the performance scenarios section may skew the retail investor’s prediction of future PRIIP performance. The recent bullish performance of the whole market leads to over-optimistic presentation of performance scenario information. In such case, FCA has recommended that the firms to provide additional explanatory material to adjust the clients’ expectations of future performances.
The new methodology for calculating transaction costs is also criticised as potentially misleading. Critics of PRIIPs Initiative suggest that market movement is included when calculating transaction costs. This will lead to a distortion of transaction cost value, as analysts tend to over- or underestimate the costs. Different managers will be making different assumptions for adjustments as the underlying data is not universally available, leading to lack of comparability between the investment figures, which can easily mislead investors.
The PRIIPs Initiative aims to eventually replace the existing UCITS Key Investor Information Document (KIID). By the end of December 2019, the European Commission will make a decision on whether to scrap the UCITS KIID for PRIIPs KID. This step could potentially help in easing manufacturers’ and advisers’ regulatory reporting burdens, but also will cause large shake-up in the existing framework. Axioma Regulatory Reporting team is a market expert in their knowledge of regulatory changes and has assisted many firms in addressing their regulatory needs. To learn more about how we can help you reduce your regulatory burdens, contact our team of experts.