The PRIIPs regulation came into effect in January 2018, with intentions to help investors understand investment products behaviour and support comparison with other investment products. As COVID-19 pandemic has led (and is still leading) the global financial markets into a “Stress Scenario”, we set out to test:
- If the PRIIPs KID methodology has provided investors with a sufficient downside scenario to match today’s market crash.
- If PRIIPs KIDs generated during the crisis still work.
For this article we will focus on the first topic, by reviewing PRIIP KIDs’ Stress Scenarios that were calculated before the crisis and compare them to actual performances. We limited our test to a few popular and simple Delta-1 instruments. In future articles, we may extend our test to more complex financial instruments.
The Stress Scenario figures in the KID should illustrate the possible performance of the investment under extreme scenarios. In order to test the effectiveness of the Stress Scenario methodology, we began with stress testing simple equity indexes/ETFs and Crude Oil. We calculated a Stress Scenario (both Long-term and Short-term, i.e. calibrated with parameters for up to 1Y and above 1Y as dictated by the PRIIPs RTS), and compared these results to the decrease from the last 52 weeks’ high, as well as from close before the crisis hit.
The scenarios were generated to start prior to the crisis in order for the scenario calibration not to account for any negative downturn in the market. For this we assumed scenarios generated on 20 Feb, 2020.
As we can see, when comparing the results of the Stress Scenario to the real downturn of the underlying, the actual performance usually does not fall below the stress test value, and therefore functions well.
Based on the few samples provided above, we can summarize:
- The PRIIPs RTS Stress Scenario methodology has provided reasonable results, in line with the effect of the current crisis.
- As we know the current COVID-19 crisis led to unprecedented falls in both the global aviation industry and oil prices (oil prices declined not only due to COVID-19 but also as a result of other factors happening around the same time). Yet, the “Long Stress” (less strict assumptions than the “Short Stress”) still delivered results not far from the actual crisis lows.
- So far, the crisis lows were still far away from the “Short Stress” figures. This is due to the overly-strict assumptions for the “Short Stress” required by the PRIIPs RTS.
Lastly, one important disclaimer: having said all the above, the crisis is not over yet. We do not know how long it will continue and what extra downturn the markets will experience. We will keep watching and update the figures accordingly.