The ESAs established
the PRIIP KID regime with the goal to present information on financial products
to retail investors in a clear and standardised manner. The presentation and
content of the KID document as well as the methodology for the calculations and
presentation of risks, rewards and costs were specifically developed to create
a better understanding. Now, with a lot of industry feedback the ESAs act on
their responsibility to review the PRIIPs RTS.
The new RTS focuses
on proposals for appropriate performance scenarios and revised presentation,
aiming at avoiding inappropriate expectations from the retail investor.
Revisions to the summary cost indicator and
better presentation of the costs support the understanding of the different
types of cost structures. In addition, the presentation and narratives have been
adjusted on multiple occasions across the document.
Since the Key
Information Document (KID) was introduced in January 2018, the ESAs have
received industry and consumer feedback. In October 2019 the ESAs provided a consultation
paper on a draft RTS on changes in presentation, content, review and revision
of the KID. Further research and the review of various methodologies resulted
in a new RTS draft which was approved by ESMA and EBA during June 2020. In
February 2021, the RTS was approved by EIOPA. The European Commission is now adjusting
the implementation timeline to July 2022 and is planning to publish the amended
RTS during Q4 2021.
While many issues and
exact requirements remain open, we have analysed the effects of the changes on OTC
Derivatives and summarised the main changes.
always have an SRI of 7, they are not directly affected by the SRI calculation
changes. Therefore, the new RTS allowing manufacturers to increase the SRI if
they feel it “does not adequately reflect the risk of the PRIIP”, adds no
further responsibility to OTC manufacturers. In addition, the VEV buckets have
been slightly amended as well as the VEV formula. Both adjustments clarify what
most manufacturers have been using anyways. Both changes do not affect OTCs.
Relevant for OTCs are the narrative changes accompanying the SRI:
- In the SRI narratives (ANNEX III),
the amended RTS adds several clarifications regarding when each narrative
should appear. Manufacturers will need to verify they are in line with those
instructions. Still, we have discovered several noteworthy typos in the amended
RTS. For example:
Note: as this is the official RTS screenshot,
the SRI is shown as “5”. Nevertheless, the SRI “7” rule for OTC is still in
- Especially for OTC, there is now an
additional paragraph mentioning, that the SRI narrative explanations should be
adjusted to reflect the specific features of the PRIIP. As an example, the
absence of an initial investment amount needs to be considered. Since more
specific adjustments can be found in the Q&As, it seems like the content
of the Q&As (April 4th, 2019) regarding OTCs have found their way
into the RTS and
thus becoming mandatory. Due to the new paragraphs requiring manufacturers to
adjust narratives to OTC derivatives’ terminology, we do not expect to see
additional adjustments for new narratives (from the new RTS) to be published
within Q&As. Those adjustments should be performed by the manufacturers
(for example, the new narratives for the new Minimum Scenario – more
information available below).
SRI section for OTCs is relatively untouched, the amended RTS suggests numerous
changes to the performance scenarios calculation and presentation. Some of
those changes warrant a closer look. We intend to further elaborate in a set of
dedicated articles. For the time being, here is a summary of the changes:
The ESAs decided to leave ‘as is’,
the historical drift and abandon the methods they suggested in order to deal
with the pro-cyclicality problem (e.g. risk premia for equities). Instead, they
allow manufacturers to use percentiles lower than 10th, 50th
and 90th for the Unfavourable, Moderate and Favourable Scenarios when
they believe the scenarios are too optimistic. There are several challenges with
- From the legal perspective, it is
transferring the responsibility to treat too optimistic scenarios to the
- From the technical point of view, it
is unclear how to quantify “inappropriate expectations”. It is simply too underlying
and payoff dependent.
- Another technical issue: it is not a
trivial task to lower the percentiles and reach an appropriate expectation. Not
to mention there is simply no guarantee of finding one.
In the Consultation Paper, the ESAs
suggested to replace the Stress Scenario with a Minimum Scenario. However, in
the amended RTS the ESAs decided to keep the Stress Scenario
, and to
require, in addition, the Minimum Scenario
In the Minimum Scenario, the minimal value in monetary terms should be
specified. Usually, for OTC derivatives there are no guarantees. There are two
typical cases: (a) the minimum is zero, for products such as options. For those
you will need to say there is no minimum (b) there is no minimum, for products
such as forwards and swaps. For those you will need to add another clause that
claims you might need to pay more to cover losses.
3. Intermediate Holding Periods (IHPs) –
the ESAs decided to keep 1Y IHP as of today (i.e. for RHP longer than a year)
and discard RHP/2 for products with an RHP less than 10 years. For
products with a 10-year RHP or more, there will be three Holding Periods, similar
to the current RTS.
4. Monetary unit rounding – the amended
RTS requires rounding the values to 10 EUR (or equivalent in
other currencies), unless “it could be misleading to round the figures”. In
these cases, the RTS requires rounding to 1 EUR. It is unclear what those
“misleading” cases are. In addition, with the current low interest rate
environment, 10 EUR rounding, especially for 1Y IHP, is not negligible. Two
examples for specific pay-out conditions might be Coupons with precisions lower
than 0.1% or Caps and Floors with precisions lower 0.1%. Perhaps, these are the
cases the ESAs mean “misleading”.
5. The amended RTS clarifies that
intermediate cash flows, such as coupons, will not yield a return. This is in
line with EUSIPA’s Recommendations 4.1.A and 4.1.C available at: https://eusipa.org/eusipa-rts-implementation-advice-published/
6. The ESAs finally clarified what
formula should be used for the “Average return each year” for forward
contracts, future contracts, contracts for difference, or swaps. It is simply:
“(Net profit or loss / Notional Amount)^(1/T) – 1” if T>1. A footnote
shall indicate that the potential return is calculated as a percentage over
the notional amount. In case the Net profit or loss of the KID is negative,
this formula is not well defined. As the RTS does not provide another solution,
we print “N/A” in the KID as any other calculation would be misleading for the
retail client and it would deviate from the RTS specifications.
Now that the calculation formula has been clarified, all Manufacturers using
non-compounded returns and other variations will need to adjust their
implementation. For RHPs shorter than 1Y, the amended RTS explicitly states
that the return should not be annualized, similar to what have been already
published in the Q&As.
Still, we are left with the usual open questions: what about OTC options?
Instructions are also missing for which Notional Amount should be used if an
OTC has more than one Notional (e.g. leverage TARFs or accumulators, Amortizing
7. The ESAs require adding a brief
description (up to 300 characters) of the presented scenarios. There are
a few more changes to the current existing narratives. For OTCs, the terminology
should also be adjusted where appropriate to reflect the specific features
of the PRIIP, such as to refer to the notional amount of the PRIIP.
the performance scenarios section, the costs section includes plenty of
As for the
presentation of costs, the ESAs decided to keep the two cost tables. Similar to
the current RTS, the first is the “Costs over time” table and the second is the
“Composition of Costs” table. Still, their contents have changed as
over time” table:
the performance scenarios table, RHP/2 should appear only for PRIIPs with a
recommended holding period of 10 years or more.
concept is still used, but with a few changes:
has been renamed “Annual cost impact”.
simple description explains the concept in a narrative below the table,
showing the return at RHP before and after the costs.
Moderate Scenario is used for the RIY calculation only for RHP and RHP/2 (if
presented). For 1Y IHP, a net performance (i.e. after costs) of zero is used to
calculate the RIY. This is mainly for achieving better alignment with costs
presented in MiFID II.
shorter than 1Y, the amended RTS explicitly states that the RIY should not
be annualised, similar to what has been already published in the Q&As.
In this case, the RIY at RHP should be based on zero net performance and the label
should say “Cost impact” instead of “Annual cost impact”.
of Costs” table will include three columns:
item name - performance fees and carried interests will be combined to one
line, but these cost items are irrelevant for OTC.
– a flexible description of the cost. The RTS suggests a few wordings,
usually including the raw costs. For example, for entry cost: “x% of the amount
you pay in when entering this investment”. However, these are just sample
narratives, and the Manufacturer can decide which wordings to use. For example,
for OTC derivatives, in the exit costs it is useful to explain they are applied
only if the investor exits early.
RIY at RHP (which is kept only for IBIPs, i.e. insurance-based investment
products), for other product types, including OTCs, the third column should
show costs in EUR if the investor exits after one year (or RHP if it is shorter
than a year).
a challenge to long term OTCs (e.g. 10Y IRS) as the costs are usually charged
upfront. While investors typically hold classical OTCs until maturity, assuming
an exit after one year will show the full cost charged upfront plus the early
exit fee charged after one year. This is not a fair representation of the costs
of those products.
is now RTS, so check your OTC KIDs
In a few cases the
exception in the wording for OTCs have found their way into the regulation.
While not all details and separate narratives are included, the RTS now
mentions at multiple places the use of “Notional” instead of investment.
Therefore, implementations and current KIDs not up to the Q&A standards
need to review their setup.
to discuss | What's still unclear
Even though the
timeline is not finalised yet and the RTS not approved, still, it looks as the
RTS will be approved as is (except for the 6 months delay). There are
additional open questions and therefore industry alignment is necessary.
In case of the Performance
Scenarios, the responsibility has shifted to the manufacturer to decide if a
scenario is too optimistic and might be misleading. The decision when to use
this mandate, the exact quantification and methodology – they all should be
aligned at the industry level to eliminate comparability issues.
As for the scenario
description, there is no sample text in the RTS for Category 1 products. How
elaborated these should be? Should they be product type dependentor general
ones? Again, it would be preferable to have an industry consensus.
to find further material
The above information
is based on the original PRIIPs
Q&As and the final draft
for the PRIIPs
KID RTS. For more
information and current discussions, please join our LinkedIn PRIIPs RTS
Preparation Task Force or get in
touch with us. We are happy to arrange in depth sessions with our PRIIPs
experts and provide you with additional material. As the timeline moves along,
we will continue to publish articles on this topic and provide further