PRIIPs RTS calculation methodology for performance scenarios: what’s new?

Introduction

The Packaged Retail and Insurance-based Products (PRIIPs) Regulation aims to provide clarity and protection for retail investors. However, the financial industry has been critical of the prescribed methodologies for various disclosures since its go-live date in January 2018.

In response, the European Parliament and Council approved amended regulatory technical standards (RTS) in September 2021 to provide better information to retail investors. These new RTS, effective from 2023, will change the way costs, charges and performance scenarios are calculated and displayed and introduce template amendments.

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One of the financial industry’s main concerns was the calculation methodology for performance scenarios, previously deemed misleading to retail investors. These new RTS are intended to address these issues and reflect financial market behavior more closely.

This article looks at how the new methodology works and provides examples of how to compute performance scenarios under the new regime.

General requirements

With the new RTS, PRIIPs manufacturers will need to source longer-term pricing data to compute performance scenarios. Previously, 5 years of performance data was used, and in some instances even less was acceptable. Now, the new methodology requires a maximum of 10 years or 5 years more than the product’s recommended holding period (RHP), and financial market participants should consider proxies to complete price histories where needed.

The new guidelines also offer a more prescriptive methodology for selecting proxy data, so it’s recommended that financial market participants review and potentially change their proxy selection process. It’s also worth noting that share classes from the same sub-fund, when adjusted for the cost structure, can be considered as the actual product’s return rather than a proxy.

As in the 2017 RTS, the scenarios should be compiled net of all costs and on the basis that dividends have been reinvested.

Methodology change for unfavorable, moderate and favorable scenarios

The 2017 RTS calculation methodology for performance scenarios relies on the distribution of historical (daily) returns, which are input into a Cornish Fisher model applied at different percentiles. This representation aims to capture scenarios ranging from unfavorable to favorable.

In comparison, the new 2021 RTS calculation methodology for performance scenarios takes the worst, median and best evolution of a product’s real performance in rolling interval windows.

Two different data sampling processes must be used with this new model.

Data sampling process #1:

1. Start from the reporting date
2. Select sub-intervals of length equal to RHP
3. Move in 1-month increments
4. End when the full net asset value (NAV) price history has been used

Data sampling process #2:

1. Start from the reporting date (for each data sample)
2. First data sample is 1Y length
3. Add one trading period for each sample (e.g., for daily priced funds, add a working day for each data sample)
4. End when you reach reporting date–RHP years (or the length of the sample=RHP)
   

For data samples resulting from process #2, we can also observe the performance over the period. While these correspond to different period lengths, we should consider them as they are, i.e., assume that the return occurred over the same period. We also order these returns and record the worse one.
Finally, we select the minimum between the worst values of process #1 and process #2 as the unfavorable performance scenario.

When building scenarios for intermediate periods for PRIIPs with an RHP greater than 10 years, we should start with data sampling and substitute the RHP accordingly.

This table compares the results between the 2017 RTS and the new RTS for an illustrative fund with an RHP of 5 years, as well as the fund’s annual performance.

Lower impact methodological changes

Here’s a summary of the changes brought by the new RTS that have a lower operational impact but that financial market participants should still be aware of.

Rounding

In the PRIIPs key information document (KID), performance scenarios should be showcased in monetary terms and rounded to the nearest EUR10. These values should also be compared to the value of the initial investment to obtain the annualized percentage return, rounded to 1 decimal place.

Intermediate holding periods

PRIIPs manufacturers must still calculate the performance scenarios for different time horizons and up to the RHP. However, the new RTS prescribes that for PRIIPs with an RHP of under 10 years, only values at 1 year and RHP should be presented to retail investors.

Stress performance scenario for category 2 PRIIPs

While the overall methodology for compiling stress scenarios remains unchanged, the quantile used to determine the stressed volatility for holding periods over 1 year has risen from 90% to 95%. For all holding periods over 1 year, this will lead to higher stressed volatilities and, therefore, more severe stressed scenarios.

The new RTS also addresses the potentially misleading event of a stress scenario producing better figures than the unfavorable scenario by flooring the stress scenario to the unfavorable one.

New PRIIPs RTS for private equity and real estate funds

While the rules for category 1 products haven’t changed, a new provision allows PRIIPs manufacturers to use lower quantiles than those in the RTS if there is a material risk these scenarios will provide investors with inappropriate performance expectations.

Conclusion

As the new PRIIPs RTS calculation methodology for performance scenarios will come into effect on 1 January 2023, it is essential that financial market participants understand the operational and data requirements and how they are affected. It is likely that PRIIPs data and the new performance scenarios will need to be exchanged in the third and fourth quarters of 2022, to allow enough time for third parties to prepare the PRIIPs KIDs.

Deloitte has a proven track record in helping our clients smoothly and successfully migrate to new regulatory regimes. Visit our PRIIPs overview and PRIIPs reporting services pages for everything you need for a successful PRIIPs migration, or get in touch with our professionals for tailored support.