Evaluation of the investor experience

A few years have passed, since the first introduction of the PRIIPs regulation in the European Union. Investment funds for which the UCITS exemption did not apply, have been preparing so called ‘Key Information Documents’ (KIDs) ever since early 2018. Soon after a series of amendments to the regulatory technical standards had been proposed, the European Commission has requested a comprehensive review of the scope of the PRIIPs regulation and the contents of the KID. On April 27^th this year, the European Supervisory Authorities have submitted a written advice as a result of such a regulatory review. In this blog, RiskQuest will highlight a few important recommendations from the ESA advisory report:

• Replacement of the performance scenarios by information on historical performance for non-structured linear products;
• Scope refinement for, among other products, bonds by inclusion of a non-exhaustive list of products that are in or out of scope for the PRIIPs regulation;More alignment between cost disclosure in the PRIIPs KID with other regulation on disclosure, like MiFID;
• Additional guidance for multi-option products, where the costs depend on the investment alternatives chosen by e.g. the investors by making a break-down of general costs and costs specific to the investment alternative selected.

1. Commission request for advice

The European Supervisory Authorities[1] (ESAs) have submitted a written advice on April 27^th 2022 about the review of the PRIIPs regulation following a request[2] received from the Commission on 27 July 2021. Overall, the ESAs suggest a substantial amount of changes to the PRIIPs Regulation and encourage the co-legislators to consider a broad review of the PRIIPs framework. The ESAs also think that it is important that before proposals are made to change the PRIIPs Regulation appropriate consumer testing is conducted. The focus of the regulatory review has been primarily on the level 1 regulation about the contents of the KID and the scope of products for which a KID is required. The changes to regulatory technical standards discussed in RiskQuest’s latest PRIIPs blog, will not be further adjusted before implementation on January 1^st 2023. In the remainder of this blog, a recap on the regulatory developments since 2018 will be provided first, after which the advice of the ESAs will be summarized.

2. Developments PRIIPs regulation since 2018

In response to the industry concerns[3] about unrealistic return forecasts, the ESAs published a consultation paper on November 8^th 2018, in which three possible solution directions were proposed: (1) introducing a trend correction in the performance scenarios (risk-neutral simulation); (2) replacing the performance scenarios with a confidence interval of the return; (3) extending the mandatory price history from 5 years to 10 years. On February 8^th 2019, the ESAs published a report with the preliminary amendments to the PRIIPs Regulation, based on the feedback on the consultation paper from the industry. This showed that the representatives of PRIIP products did not support all three solution directions and that the PRIIPs Regulation was therefore not being amended for the time being.

Disagreement between the ESAs followed, and finally in 2020 a draft Regulatory Technical Standard (RTS) was sent to the European Commission. However not all ESAs approved this new draft, and it took until February 3^rd 2021 for all of them to agree. This RTS will be implemented[4] by the European Commission, Parliament and Council on January 1^st 2023 for all PRIIPs. That is, the exemption that existed for Undertakings for Collective Investment in Tradeable Securities (UCITS) will end on the same date. While the industry was preparing for the implementation of the finalized level[5] 2 regulation, the Commission asked advice from the ESAs on some disputed level 1 topics. As a result, the ESAs have reviewed the PRIIPs regulatory framework since August 2021 and published their written advice on April 27^th this year.

3. ESA advice on the review of the PRIIPs Regulation

3.1Performance scenarios

Probably one of the most impactful suggestions put forward by the ESAs is the replacement of the current performance scenarios with past performance information for certain funds. In order to provide advice that is supported by the asset management industry and consumer associations, the ESAs invited[6] stakeholders to provide input on a range of regulatory PRIIPs topics (e.g. performance scenarios) on October 21^st 2021. Several stakeholders indicated that the future performance scenarios in the current regulation are too complex for retail investors. However, stakeholders from the structured products industry generally stated to keep the current methodology for performance scenarios, because they consider these forward looking projections as adequate information for retail investors. Hence, the ESAs advise the European Commission to allow the replacement of performance scenarios in the KID by information on past performance for non-structured investment funds and other linear products.

3.2 Scope

In 2019 the ESAs published a Supervisory Statement[7] on the application of the scope of the PRIIPs regulation to bonds, since the asset management industry had raised a multitude of questions about on the topic. The Statement provided guidance on the practical application of the provisions determining the scope of the PRIIPs regulation to different types of common bond features. For instance, the ESAs explained that, among other features, a ‘perpetual’ or a ‘subordinated’ feature of a bond does not imply that the bond falls in scope of the PRIIPs regulation. The ESAs asked the industry in October 2021 for feedback on the Supervisory Statement regarding bonds. The vast majority of the stakeholders expressed support for the Statement while also stating that there remains legal uncertainty on the application to bonds, since the Statement is non-binding in nature. Some respondents also argued that guidance is needed for additional features, in particular “make-whole” clauses. Therefore, the ESAs advise the European Commission to amend the PRIIPs regulation in line with the Supervisory Statement on the scope for bonds. Moreover, the ESAs recommend to include in the PRIIPs regulation a significantly longer non-exhaustive list of products that are in or out of scope of the PRIIPs regulation. The ESAs offered to draft a proposal for such a list, when requested by the European Commission.

3.3 Alignment of costs disclosure

Another topic for which the ESAs have requested feedback from the asset management industry in October last year, was the alignment of the cost section in the KID and information on costs in other disclosures. In general, respondents highlighted the importance of full alignment of costs disclosure in the PRIIPs KID with other regulatory disclosure requirements. In particular, alignment with the Markets in Financial Instruments Directive (MiFID) is considered to be important, but also the Insurance Distribution Directive was mentioned. When comparing the cost section in the PRIIPs regulation with MiFID and IDD, a few differences come to light. Where MiFID requires that costs are computed under a 0% return assumption, the PRIIPs regulation does not require this such that performance related fees are appropriately addressed. The IDD and the PRIIPs regulation are not in line with respect to the extent to which insurance premia should be taken into account as costs. Market participants also raised that the high number of cost figures to be displayed in the PRIIPs KID compared to disclosures under MiFID and IDD, could reduce investors comprehension of the KID. In relation to the feedback on costs provided by market participants, the ESAs have started working on Level[8] 3 guidance to help stakeholders to implement the revised PRIIPs Delegated Regulation (level 2), such that, as far as possible, this guidance is published in advance of the implementation date, January 1^st 2023.

3.4 Multi-Option products

Stakeholders provided the ESAs with feedback on potential alternative approaches for multi-option products (or ‘MOPs’). Multi-option products are often insurance contracts where (part of) the insurance premia are invested under an investment policy selected by the retail investor. For MOPs the costs of the PRIIP depend on the chosen investment option. The majority of stakeholders representing insurance providers, as well as some respondents from the asset management and banking sectors, stated their preference for maintaining the existing approaches allowing the PRIIP manufacturer to choose between preparing a KID per investment option, and preparing a generic KID and a specific information document for each investment option. The ESAs see substantive benefits to additional transparency and consider that it can be relevant to introduce a split or breakdown between the costs of the insurance contract and the costs specific to the investment options for all MOPs. However, stakeholders indicated that there are different interpretations as to whether the specific KID per underlying investment option should include also the costs of the overarching insurance contract or not. The reason for this, is that the overarching insurance contract costs are often immaterial compared to the costs related the chosen investment option. Therefore, the ESAs propose to require the inclusion of all product costs in the KID per investment option, only where the costs of the insurance contract are significant. A significance threshold could be calibrated in the PRIIPs level 2 regulation. Finally, when considering the appropriate investment options, it is expected that retail investors might wish to conduct an initial filtering between investment options, for example based on the recommended holding period (RHP), summary risk indicator (SRI) or exposure class. The ESAs acknowledge that it is not straightforward to use the KID or links to the KID for this. Consequently, it would be beneficial for retail investors if there would be a way to filter more easily between investment options, either by using an online filtering tool or by having very short high-level information on each investment option in the same place or document (i.e. a summary table).

Conclusion

The written advice submitted to the European Commission by the ESAs on April 27^th 2022 make clear that the amendments to the PRIIPs regulation to be implemented on January 1^st 2023, will not be the last adjustments to the regulatory framework. Except for the additional guidance on MOPs, further amendments regarding scope, past performance and cost disclosure are likely to be introduced and implemented next year the earliest. In the meantime, RiskQuest will follow regulatory developments closely, so stay up-to-date and keep an eye on our website!

[1] Existing of the European Securities and Markets Authority (ESMA), European Banking Authority (EBA) and European Insurance and Occupational Pensions Authority (EIOPA).

[2] https://www.eiopa.europa.eu/si...

[3] For details, please refer to RiskQuest's white paper from 2019 on this topic.

[4] https://www.europarl.europa.eu...

[5] Level 1 is the high level PRIIPs regulation from 2014 about the contents of the new Key Information Document (KID) and which funds should publish a KID. Level 2 regulation from 2017 detailed the calculations, figures, tables and texts for the KID. Level 3 regulation is the collection of Question and Answer (Q&A) documents published by the ESAs after 2017, in which questions of the asset management industry are answered.

[6] https://www.eiopa.europa.eu/media/news/esas-invite-stakeholders-input-priips-review_en

[7] https://www.esma.europa.eu/sit...

[8] Level 1 is the high level PRIIPs regulation from 2014 about the contents of the new Key Information Document (KID) and which funds should publish a KID. Level 2 regulation from 2017 detailed the calculations, figures, tables and texts for the KID. Level 3 regulation is the collection of Question and Answer (Q&A) documents published by the ESAs after 2017, in which questions of the asset management industry are answered.