The controversy around the PRIIPs regime rages on.
SEQVOIA's longstanding mission has been to help its clients achieve information consistency and regulatory compliance. We've recently expanded on this by integrating calculation services into our established platform for document production and data dissemination. It’s therefore critical that we closely follow the ongoing battle for the future of PRIIPs, and share our perspective with our clients.
A basket of ideas
Toward the end of May, the European Supervisory Authorities (ESAs) wrote to the European Commission (EC) laying out a number of potential revisions to the presentation of performance-scenario information in the PRIIPs KID that should be tested with consumers. In their document, they offer several possible ways to summarize and visually represent this information, in order to determine which approach is clearest and most meaningful for the common investor. None of their proposals details the specific methodology to be used in producing the data underneath the tables and charts; this is strictly intended to evaluate the presentation options.
Some of their designs feature a “past performance” element, which was formally offered by the ESAs for consideration back in November. This will be very familiar to anyone who has worked with UCITS KIIDs, and appears to draw on the same basic methodology.
Proposal for showing “past performance” on an updated KID.
When this was originally suggested as a “quick fix” last year, many observers noted that while it makes sense for the typical investment fund, it’s difficult if not impossible to generate the same historical view for other types of PRIIPs (e.g. IBIPs, structured funds, and so on). Because the current ESA proposal doesn’t discuss how these elements are to be produced, it’s unknown how those concerns can be addressed.
Several of the design options offered by the ESAs also include something they’re calling a “probabilistic” table, which could replace the “performance scenarios” table featured on the current KID. Again, the proposal doesn’t describe how these numbers are to be derived, but close examination suggests the likely source and intention.
Proposal for “probabilistic” table.
While comparison with the current “performance scenarios” table shows a few differences, such as the reduction of a range of holding periods to the single recommended holding period, the underlying statistical approach appears to be largely unchanged. Essentially, this seems to be the existing projection model, reformatted and reorganised. There are still four scenarios, representing a range of market behavior, generically labeled as “favourable,” “moderate,” and so on. For each scenario, returns are (apparently) forecast according to the potential movement of the market.
The table also adds an “estimated chance” column, which seems to compare each given scenario to the overall set of simulations. As above, the specific methodology isn’t explained, so the intention is unclear. Is it the probability curve for the complete set of forecasts, showing the relationship between the moderate and favorable scenarios? Or is it intended to reflect probability within each scenario? Whatever it means, it seems to risk adding confusion to what is already a suspect indicator. And further, it persists the dubious practice of implying mathematical rigor in what is fundamentally an unreliable guess about an unpredictable future.
For comparison, there’s a very different new idea in the ESAs’ design proposals, one that appears to move away from trying to predictively model the market going forward. They call this the “illustrative scenarios” table.
Proposal for “illustrative scenarios” table.
This approach, at a glance, abandons the subjective “favourable/unfavourable” labels and the hypothetical projections of the current KID, and instead presents simple performance tiers and the associated results, with no attempt to attach probabilities to those outcomes. If the market does X, in other words, your investment can be expected to return Y. This apparently shifts responsibility back to investors, asking them to consider their own opinions of the market’s potential before making their financial choices.
It should be noted, however, that at no point is there any discussion of what “after costs” represents in the tables. One of the most difficult and controversial aspects of the current regulatory framework is the attempt to capture the implicit costs involved with trading in the market, on top of the explicit, and more easily identifiable, costs and fees the investor is likely to incur. If the regulators are, in fact, looking at the contentious question of whether to carry on with the arrival-price calculation, as indicated in their final report from February, they don’t give any indication of their thinking in this material.
Slings and arrows
The EC responded to the ESAs’ document on 19-July. In a short, tersely phrased letter, the ESAs are advised that only some of their performance-scenario options will be accepted for the consumer-testing effort. Several of the ESA’s proposals have been deemed improper or unsatisfactory on a number of grounds, and will be excluded from testing.
The reasons vary from item to item: impracticality (the design is likely to result in a KID exceeding the three page limit), redundancy (the design is similar to another in the same set, and doesn’t need to be tested separately), non-compliance (the proposed content violates the regulation and would be unacceptable regardless of test outcome), and so on.
Direct quote from the EC’s letter: “After a careful assessment of the proposed options with regard to presentations of performance scenarios, as submitted by the ESAs to the Commission on 23 May 2019, only those options that comply with the requirements of the PRIIPs Regulation 1286/2014 and make sense in terms of practical feasibility, will be subject to consumer testing.”
A week and a half later, the ESAs replied, arguing strenuously against the EC’s determinations. “We are not convinced by the explanations that you have provided,” their letter says, and proceeds to rebut, point by point, each of the EC’s positions. “We disagree” … “we do not share the view” … “we think it is premature” … and so on. It’s unusually direct for a bureaucratic communication.
Most significantly, the ESAs respond directly to the EC’s directive that options must comply with the regulation to be eligible for consideration in this process. “As we stated earlier this year, while we are strongly focusing our work on changes to the Delegated Regulation 2017/653, we may also provide advice regarding the Level 1 Regulation,” the letter says. “This would be on the basis of our Boards judging that, in line with our mandates and based on experiences to date, requirements of the Level 1 Regulation contain impediments to achieving a KID that meets the intended objectives.”
Translated from bureaucrat-speak to plain language, this is what they’re saying:
EC: “Some of your proposals are outside the existing law. We have no intention of amending it. Stay inside the lines.”
ESAs: “Actually, we think your law is exacerbating the problem. And we’re planning to tell you to change it.”
To date, the EC has made no official public response to this rather pointed criticism.
It’s not surprising that the politicians in Parliament and the EC would be reluctant to admit that their lawmaking has been flawed. Further, while industry and consumer-protection groups should be encouraged by the regulators’ politely worded but direct rebuke to the politicians — conveying not just the ESAs’ apparent recognition of the larger problem, but their willingness to confront the political obstacles in the path of fixing it — some observers clearly believe even this broader focus doesn’t go far enough.
For example, in a consultation response from September about costs and charges disclosures under MiFID II, the trade association EFAMA takes the opportunity to remind regulators yet again about the problems with PRIIPs, describing the information in KIDs as “generally not usable” and “hardly comprehensible,” entailing “high liability risks” for the investment industry.
Further, in its annual report from May, the industry group Insurance Europe bluntly says the PRIIPs rules “are simply not working.” Its analysis calls out the performance-scenario metric’s extrapolation of recent history into the future as being particularly misleading. “Where consumer testing does not provide a clear answer,” says the report, “policymakers need to be brave enough to go back to the drawing board and start again, not accept the least bad option.”
Looking into the future
While the general outlines of the pending changes are starting to come into focus, it’s impossible to say with any certainty what will ultimately be decided. The positions of the various players seem fairly clear, and some form of compromise is inevitable, but there’s a wide range of plausible outcomes on the horizon.
SEQVOIA has foreseen the likely reconsideration of the PRIIPs regime even before the postponement of the transition was made official last year. In designing our solutions, we have aimed for maximum flexibility, creating modular functionality and drilling down as far into the underlying core data as possible. This allows us to accommodate the needs of different clients, with their unique operational models and data frameworks. But it also gives us a solid foundation for adjusting to regulatory changes as soon as they’re finalised. By building our solution based on the fundamentals, we’ve made it possible to quickly adapt to new outputs as rules and requirements evolve.
We at SEQVOIA understand our responsibility to our clients. We know they rely on our expertise, in both technology and the business, and our ability to reshape our solutions in a rapidly evolving regulatory landscape. We are committed to delivering software and services that comprehensively answer the concerns of a demanding industry.
Whatever happens with PRIIPs, SEQVOIA will be ready.