Until year end 2021 the manufacturers of structured products, OTC derivatives, UCITS funds and AIF are facing a lot of regulatory work. They are required to identify and implement amended regulatory technical standards (RTS) on the key information documents (KID) for packaged retail and insurance-based investment products (PRIIPs) approved by the European Supervisory Authorities (ESA) on 3 February 2021.
Affecting manufacturers, distributors and investors
The new rules expose manufacturers with a complex task. However, irrespective of whether someone considers the amendments are helpful or not, they significantly affect the methodology and the content of a KID culminating partially in a break in the continuity with the current standard. Therefore, distributors as well as investors have to be carefully trained in order to get familiar and to understand all new features of the future KID.
The current KID has been applicable for structured products and OTC derivatives since January 2018. Due to the envisaged inclusion of UCITS funds and AIF and the widespread criticism concerning a lack of informative value, the ESAs started a joint consultation in October 2019. The ESAs agreed on a final report on RTS amending the PRIIPs Regulation and submitted it to the European Commission for the final decision in February 2021.
The final approval of the RTS proposal in its current form is expected for April 2021 at the latest. Initially it has been envisaged that the RTS will come into effect by 1 January 2022. However, there are signs that the European Commission could postpone the implementation by three, six or even twelve months. At a later stage, the ESAs might publish level 3 guidelines or Q&A on various topics. Industry associations are already requesting for clarification on certain topics.
The lobbying of certain parts of the industry for postponing might have been successful – similar to what happened to the current active RTS, which initially should have been implemented by January 2017, but then started twelve months later. However, everyone could hope but should not bet on such a concession as the European Commission itself had put pressure on the ESAs for a quick submission of the amendment. Another subsequent last minute stop – in theory a non-objection of the RTS by the European Parliament or the European Council - appears improbable.
So, the manufacturers should hurry up to meet the deadline, as the new RTS will not only apply to new offerings, but also for existing products which are still be offered. The new RTS do not contain any grandfathering clause, so that the issuers have to decide for existing products whether to switch the KID or to close the offering at the time when the new RTS will come into effect.
Need for industry alignment
The amendments require additional content and cover almost all sections of the current KID. Manufacturers might question the current page limit for a KID. This limit of three pages remains untouched as it is part of the level 1 regulation while the amendment constitutes a level 2 regulation only.
Ayal Leibowitz, Chief Innovation Officer at LPA/Modelity has advocated more industry alignment. His claim is that a KID does not offer a competitive advantage. It is even counterproductive, if KIDs across different manufacturers show different results for identical items. In addition, the new RTS leaves many questions unanswered. Therefore, the manufacturers should agree on a coordinated, industry wide standard. It could not be expected that the ESAs will provide all-embracing level 3 advice in good time.
A long list of amendments
The RTS includes significant changes on the KID regarding methodology, additional scenario analyses, calculation of annual return and cost as well as brief explanations in plain language. Some selected examples might demonstrate the widespread impact on the KID.
- A far-reaching amendment especially refers to UCITS funds and AIF as well as structured products classified so called “category 2”. The back-testing of the different scenarios has to be based on data which exceeds the recommended holding period (RHP) by at least 5 years, but covers a minimum of 10 years, instead of currently 2 years.
- A new “minimum scenario” has to be included in addition to the stress, unfavourable, moderate and favourable scenarios.
- If a manufacturer considers a scenario too optimistic, it is responsible to use lower percentiles for that scenario.
- Specific performance scenarios as well as cost presentations are required for the high-volume category of autocallable structured products potentially ending in confusing results.
- Costs are now more but still not fully aligned with MiFID II complicating the parallel use of documents. Narratives without prescriptive wording are required for the presentation of cost.
- New narratives apply for distribution fees being inconsistent with current statements.
- In case the manufacturer considers the summary risk indicator (SRI) does not adequately reflect market and credit risks it may decide to assign the product to a riskier category.
- As before, the list of OTC derivatives does not include OTC options. Consequently, no specifications are made for example regarding the calculation of the average return.
Seeking a trusted partner
Manufacturers need to find a trusted partner who has deep expertise and can provide guidance to navigate the RTS amendment. LPA can combine the expertise of fund and structured products specialists, lawyers, mathematicians and IT specialists to cover all products under scope of PRIIPs (funds, insurance-based investments, structured products and OTC derivatives). Furthermore, LPA extensive experience and coverage of the complete value chain from initial assessment to final implementation can provide manufacturers with substantial economies of scale.