Like many film franchises, the PRIIPs regulation story likes to end with a plot twist which leads to a sequel.
The first twist
PRIIPs was originally scheduled for introduction on 31 December 2016, one full year prior to MiFID II. However, on 8 December 2016, four weeks before the original implementation date, the regulation was postponed twelve months. There were a number of reasons, one of which was that the implementing directive was rejected by the European Parliament earlier that year. The final regulatory technical standards were subsequently agreed and published on 8 March 2017.
At that time it had been foreseen that UCITS funds which have had a Key Investor Information Document (“KIID”) since 2011 would be allowed a 24 month extension to the implementation date – known as the UCITS KIID sunset period – which was due to expire 31 December 2019.
Twist two – a pair of deadline extensions
First, on 3 December 2018 the European Parliament supported a delay to the UCITS effective date for a further 24 months. The fund management industry welcomed the delay and continue to highlight areas of improvement within the regulation in the best interests of investors.
Second, the PRIIPs regulation foresaw a review to determine whether the regime achieves the desired goals and identify any undesirable unintended consequences, possibly leading to amendments to the regulations. This review was originally due 31 December 2018, but the European Commission (“EC”) requested an extension until the end of 2019.
What is unusual in the case of the PRIIPs regulation and particularly for UCITS funds is that this time the EC is due to review the implementation of the PRIIPs regulation and assess if improvements can be made prior to the PRIIPs KIDs ever being implemented for UCITS (and AIFs which produce KIIDs).
Now, the new twist
(and good news for investment funds)
On 8 February 2019, the European Supervisory Authorities (“ESAs”) issued their , closing the consultation they started 8 November 2018.
The report offers three key takeaways for fund managers.
1. Effective immediately, in circumstances where the PRIIPs manufacturer believes the future performance scenarios are misleading, the ESAs recommend including a statement, in bold, under the “Performance scenarios” heading in the “What are the risks and what could I get in return” section.
2. There will be a wide ranging review of the PRIIPs regulation during 2019, and not a “targeted review” as proposed in the 8 November 2018 consultation paper. This was a strong lobbying point for the fund industry. The wider review will consider in particular these six items:
- Performance scenarios
- Potential inclusion of UCITS in scope
- Costs (notably transaction cost methodology and the “reduction in yield” approach)
- PRIIPs offering a range of options for investment
- Differentiation between different types of PRIIPs
- Other specific changes (for example, to ensure consistency across Member States)
3. The ESAs are aware of the need to extend a number of UCITS KIID exemptions until 31 December 2021. They should also advise the co-legislators (European Parliament, European Commission and European Council) to consider removing the requirement to produce a UCITS KIID for Professional investors.
What UCITS managers are concerned about
The fund management industry have been advocates for the usefulness of the KID to investors since the earliest days of the PRIIPs consultation process. Having recently undergone the implementation of UCITS KIIDs, it is reasonable that UCITS fund managers would have first-hand experience in the types of issues encountered when implementing new investor protection regulation in the form of a two or three page KIID or KID. Industry professionals have highlighted three key pain points with PRIIPs for which they say attention is needed:
- Basing future performance projections on historic returns seems to contradict the notion that “past performance may not be an indicator of future performance” and creates a false momentum for the persistence of past returns.
- Combining several types of risk into a single composite score fails to adequately inform investors about their risk exposures.
- At a minimum, cost information should be described clearly and should reflect the true cost and the nature of the charging structure. The Arrival Price concept currently used is highly theoretical and is documented as leading to misleading results. Further, disclosing costs without disclosure of the portfolio turnover figure greatly limits the comparability of products. Lastly, it would be more useful to disclose discrete annual calendar year costs rather than uniquely disclosing one, three and five year averages.
The fund management industry’s voice is being heard, and it is these same points that have convinced the European Parliament to allow an additional 24 months for UCITS to adopt the PRIIPs KID format.
The fund management industry welcome the more holistic review now proposed by the ESAs.
Mutually exclusive, collectively exhaustive
We perceive the price of a chocolate bar very differently
when we understand all the factors that go into it.
Transparency is best when the values are presented in a mutually exclusive and collectively exhaustive manner, a concept often promoted by McKinsey & Company. Presenting elements of the cost structure distinctly and discretely — e.g. separating implicit from explicit cost — provides greater insight and allows better comparison than blending the elements into a single transaction-costs figure.
On the calculation of costs
The PRIIPs Arrival Price rules require the PRIIPs manufacturer to calculate the transaction cost encountered when managing the fund’s portfolio.
This could be taken a step further by informing investors of explicit transaction costs charged by both the public (i.e. taxes) and private sectors. The PRIIPs regulation has required manufacturers to capture these cost points, but the information value has been diluted by the requirement to disclose the aggregate value as a three year average.
Risks and Performance scenarios
This notion of separating data that should not be aggregated underpins the UCITS industry’s concerns with the PRIIPs risk calculations.
Blending different risks types into one unifying value is unlikely to offer clear information; you can’t best understand the origins and nature of risk when you’re seeing only the aggregated figure.
Furthermore, while the aim of estimating investor outcomes is laudable, the reality of calculating performance scenarios based on relatively short term historical returns is flawed. The PRIIPs performance scenarios invite expectations of returns which have negligible predictive value, especially when the historical basis for the forecast is undisclosed.
It seems that the ESAs have recognized these issues and are now committed to a review of PRIIPs during 2019.
Looking ahead — next steps
- PRIIPs manufacturers should consider, for each product, if the performance scenarios as calculated are appropriate, or if the additional warning proposed by the ESAs should be added to the product’s KID.
- The European Parliament, European Commission and European Council still need to ratify the further two-year extension of the UCITS exemption (to 31 December 2021).
- The ESAs will issue another consultation paper regarding possible changes to the RTS (2017/653), and expect to propose amendments by the end of 2019.
- The ESAs may also make suggestions for changes to the Regulation (No1286/2014), likely to become effective during 2020.
Background and additional reading:
 and AIFs sold to Retail investors which have elected to produce a KID