Earlier this week, the European Supervisory Authorities (ESAs) published their much-anticipated Q&As on various aspects of the PRIIPs KID and the Commission also issued its draft guidelines on PRIIPs.
Based on the volume of questions in the Q&As, the issues of greatest concern have been the categorisation of a PRIIP and its associated Market Risk Measure (MRM), and the calculation and presentation of costs, with an emphasis, not surprisingly, on transaction costs.
Overall, we feel there was little that is completely new in the answers, but plenty of clarification on the interpretation of the final Regulatory Technical Standards (RTS) published in March. In the appendix, there is a detailed six-step process for the calculation of the transaction costs for new PRIIPs and UCITS funds.
Let’s look at the PRIIP categorisation and summary risk indicator (SRI) first:
• Manufacturers can’t simply “opt in” to Category 1 to avoid the need for any MRM calculations.
• Annex II Paras 4 and 8 of the RTS state that if “PRIIPs or underlying investments of PRIIPs” aren’t priced at least monthly, it is a Category 1 PRIIP with an MRM of 6. But the Q&As say “the determination of the PRIIP’s category addresses the PRIIP itself”, so a fund priced at least monthly investing in assets valued less frequently is not automatically a Category 1. This is sensible, as it could otherwise have caught many property funds, which don’t automatically deserve an MRM of 6.
• Flexible/multi-asset funds need to consider up to three conditions before calculating the MRM, depending on whether or not there has been a revision of the investment policy (Annex II Para 14). A revised asset allocation is not the same as a revised investment policy. Life-cycle funds, for example, are likely to reduce exposure to equities over time and increase fixed income, in which case some or all of the historical price history may not be appropriate for a forward-looking summary risk indicator. But a manager who simply decides to change the asset allocation should use the actual price history.
• A product with an unconditional capital guarantee at the recommended holding period would not be a Category 1, even if there is a lack of historical data. The MRM comes from discounting the guaranteed value back to the present day using the expected risk-free rate. A guarantee is “unconditional” if it applies irrespective of market movements and is not based on the default risk of the guarantor.
• The existence of an investor compensation scheme does not remove any need that would otherwise arise to calculate a Credit Risk Measure (CRM).
• A CRM needs to be calculated where either the PRIIP or an underlying investment that represents over 10% of the value of the PRIIP depends on the credit-worthiness of a party that is bound to make, directly or indirectly, payments to the investor.
Moving on to the costs:
• Any income from stock lending that is paid into the fund is reflected in the return scenarios (not as a negative cost), while any benefits retained by the manager are to be included in the costs.
• Overdraft charges incurred on an account operated by an external custodian are deemed as costs.
• If actual arrival prices are not available for the last three years, managers may use the opening price, or, if that’s not available either, the previous day’s closing price as the arrival price. But you need to ensure the result is accurate, fair, clear and not misleading and, if you are aware that the price is unsuitable, you should make an effort to collect more accurate intra-day prices.
• If the underlying investment is priced in a foreign currency, you should apply the FX rate “on the day of the transaction” to both the arrival and execution prices.
• If a transaction cost calculation delivers a negative number, this should be included in the overall transaction costs (not ignored or input as 0).
• “Incidental costs” only apply to investment funds, so this line does not need to be included in the Composition of Costs table for any other type of PRIIP.
• Although there is no mention of explicit costs (eg commission or taxes) in the six-step calculation for transaction costs of new PRIIPs, they are included in the transaction cost calculation in Annex VI Para 21(c)(ii) of the RTS.
There are also a few questions relating to the presentation of performance scenarios for derivatives, so if these apply to you, you should check the Q&As.
The ESAs have confirmed that they will keep the Q&As updated, but there are less than six months until KIDs need to be issued, so there is little time for further updates. That said, if you have unanswered questions, you should send them to your national regulator or the ESAs in the hope that they come back quickly enough for you to include the answer in your project plans.
The Commission’s guidelines confirm that the obligation for assessing which products are in scope of PRIIPs rests with the manufacturers and distributors of products and funds. The FCA has published a list of products it regards as being in or out of scope, but stressed that the list is not definitive or comprehensive.
Other issues clarified in the Commission’s guidelines include:
• The need for a KID depends on whether the retail investor is in the EU, regardless of where the manufacturer is located. So EU-based funds sold only to investors outside the EU will not need a KID.
• UCITS cannot choose to issue PRIIPs KIDs instead of UCITS KIIDs before 31 December 2019.
• Any PRIIP available to retail investors after 3 January 2018 will need a KID, but any product no longer available to retail investors (other than as part of existing contractual terms) after that date will not.
• Revised KIDs should be made available “promptly” following a review.
• KIDS are not intended to be issued in “real time” or “on demand”, but there is nothing to stop firms from doing so. In any event, the KID needs to be published on the company’s website.
Contact us to find out more about how FE can help with your PRIIPs regulatory requirements.