On November 8 2018, European Supervisory Authorities (ESAs) published a Joint Consultation paper on draft amendments to the Commission Delegated Regulation 2017/653 (RTS) in relation to the PRIIPs Regulation (UE No 2014/1286).
This follows the requirement to proceed with a review of the PRIIPs Regulation in 2018 and feedback provided by market participants on the need to review elements of the CDR.
The major part of the consultation paper deals with amendments to the performance scenarios computation and presentation which had received the most aggressive feedback. Some other amendments in the Consultation are also suggested for discussion.
The Consultation is open until December 6, 2018.
Amendments on the performance scenarios
The Consultation includes proposed changes to the performance scenarios shown on Key Information Documents. ESAs suggest adding past performance of the product in the KID, whenever these are available, and justify this addition by the fact that historical prices are currently used to derive performance scenarios. The inclusion of past performance would meet the following requirements:
- Past performance would be shown in addition to the performance scenarios, not replacing them
- Past performance would cover the last 10 years and would be presented on graphical format, subject to similar condition currently applicable for UCITS KIID
The requirement to show past performance would apply to non-structured Collective Investment Schemes (UCITS or AIFs) or Category 2 insurance-based products.
With regards to products which do not have past performance data such as structured notes, derivatives or Category 4 products, these would be subject to either a) a simulation of the past performance based on historical prices of underlying assets or b) no requirement to show past performance at all, depending on the feedback received from this consultation.
In terms of amendments related to the performance scenarios, the consultation paper seeks feedback for several alternative options:
- Calculation of performance scenarios based on risk-free rate of return. This lowers the risk of performance scenarios being influenced too heavily by the past 5 years’ performance of the product. However it does not capture all the factors that impact the performance.
- Show only stress and favourable scenarios to highlight the range of possible outcomes, or use a graphical presentation or the performance scenarios.
- Extend the historical range for calculation of performance scenarios and use 10 years’ history instead of 5 years. The initial idea was to reflect market downturns in the scenarios, but this option would have a limited impact as the performance scenarios calculated using a 10-year history would be done from 2020 and would not include the performance observed during the 2008-2009 crisis.
In addition, as a result of the potential changes in the risk and reward section, these would lead to an adjustment of the narratives of the performance sub-section. The consultation paper suggests that the narrative explanations are simplified and highlight the key messages that should be shown to investors.
We think that the addition of past performance is relevant for products already presenting this information in other pre-contractual or marketing documents, namely UCITS KIIDs or factsheets. These happen to give factual information to investors and were rarely challenged by market players.
We also agree that past performance calculations will present a significant challenge for manufacturers of structured products, category 4 insurance-based products or discretionary mandates. These products should be exempted to present historical performance in the KID as the added value for investors is very limited.
Other suggested amendments
MRM calculation for regular premium products
The Consultation Paper suggests an approach for calculating the Market Risk Measure (MRM) for regular premium products which is missing in the current version of the CDR. The approach consists of adapting the formula used to compute the VaR-equivalent-volatility on a year-by-year basis while also taking each scheduled investment into account.
In our opinion, this approach codifies a market practice that is already observed with some market participants and should be included as such in the amended final CDR.
Scenarios’ presentation for autocallable products
For products having an auto-call feature, the CP proposes to harmonize the presentation of the performance scenarios by showing the performance of the product only for the periods where the product is not already called or cancelled, with accompanying narratives stating whether and when the product has been called for each scenario.
This practice has also been observed with several market participants and should not be modified when being included in the final CDR.
Growth rate for calculation of the RIY
In relation to the calculation of synthetic cost indicators, namely total costs and Reduction-in-Yield (RIY), one of the main concerns raised by manufacturers is that those indicators are highly dependent on the moderate scenario return. Indeed, the level of the RIY and total costs increases together with the return of the moderate scenario and vice-versa.
This could lead to situations where products with low costs but high return on the moderate scenario could have a larger RIY and total costs than more expensive products. This offers the possibility of giving misleading information to potential investors.
In order to increase the cost comparability of products, the CP proposes that a return of 3% should be used to compute RIY and total costs, instead of moderate scenario returns.
This is a reasonable approach to present comparable costs but there is a need for further clarification. For example manufacturers can apply multiple assumptions (e.g. insurance companies having MOPs with UCITS funds as options) and these can often lead to different results.
Questions which require responses from the ESAs or co-legislator include:
- Is the 3% return considered net or gross in the calculation or RIY?
- Is the methodology being used in the RIY and total costs include an addition of the costs or a multiplication of the costs (or a mix of both)?
For the moment calculation of these costs indicators is subject to many assumptions which are currently reflected in costs that are calculated differently from one manufacturer to another and leads to missing the initial product comparability objective.
UCITS exemption ending on January 1, 2020
The Consultation Paper dedicates a full section on the end of the exemption of the PRIIPs Regulation for funds for which a UCITS KIID is produced. However the content of this section is only limited to the articles of the KIID regulation that are impacted and on whether these articles should be included in the PRIIPs Commission Delegated Regulation.
This opens the discussion on various topics of the UCITS KIID Regulation being translated into the PRIIPs CDR and confirms the intention of legislators to keep the deadline of January 1, 2020 for the end of exemption period.
On this exemption, many options remain open and we have to “wait and see” the outcomes of the consultation.
What about transaction costs?
The Consultation Paper does not include a single word on transaction costs calculations, which was the hardest pain point raised by Funds managers since PRIIPs went live in January 2018. It seems that this topic was intentionally left for a wider review of the Regulation as it appears that the feedback received from market participants is not sufficient to trigger a new discussion.
We expect the transaction costs will not to be questioned at ESA level for another one or two years thereby allowing for three years of the PRIIPs development cycle … and where the transaction costs method will be in place for the vast majority of funds.
And the next steps…
ESAs intend to submit the draft RTS to the European Commission for endorsement during January 2019. The ESAs will also publish a final report including feedback on the consultation.
It is intended that these amendments would be applicable from 1 January 2020. This is subject to the endorsement by the European Commission of the RTS, following which the European Parliament and Council would have to adopt or reject them.
Considering the proximity of the elections of the European Parliament, these processes would need to be concluded during the first or second quarter of 2019 to make the changes effective as from 01/ 01/2020. The industry will then have six months to implement the necessary changes for those already familiar with the PRIIPs KID and the UCITS/AIFs producing a KIID.