Since it entered into force in January 2018, the EU Regulation on Key Information Documents for Packaged Retail and Insurance-based Products (“PRIIPs regulation”) has been subject to much criticism from the financial industry. Its main regulatory aim is to help investors compare investment products more easily, by making their costs, potential performance and associated risks more transparent.

However, since the PRIIPs regulation’s infancy, industry and consumer representatives have raised concerns about its methods for compiling performance scenarios and calculating transaction costs, which retail investors can find complicated and difficult to understand.

In October 2019, the European statutory authorities (ESAs) issued a consultation paper that included proposals relating to performance, costs, and multi-option products. This paper aimed to respond to these criticisms in a way that was consistent with the PRIIPs regulation’s overall regulatory objectives. It also covered how the PRIIPs regulation will apply to UCITS funds when their exemption from the regulation’s scope expires on 31 December 2021.

In July 2020, the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) adopted proposals to amend the PRIIPs regulation based on feedback from the consultation. And, in February 2021, the European Insurance and Occupational Pensions Authority (EIOPA) finally agreed to support the draft regulatory technical standards (RTS), as long as the PRIIPs Level 1 regulation is reviewed.

The new RTS were endorsed by the European Commission in September 2021, and later in the year also approved by the Parliament and the Counciel. In November 2021, the European Parliament voted to extend the UCITS exemption and postpone the new PRIIPs Regulatory Technical Standards (RTS) by 6 months. Therefore, the go-live date of the new RTS and end of UCITSPRIIPs exemption for UCITS and AIFs producing a UCITS KIID is now 1 January 2023.
 

What are the main changes brought by the new PRIIPs RTS?

The new RTS were designed to solve some of the PRIIPs regulation’s flaws, by introducing changes to the methodology for calculating performance scenarios and costs.

First, the new methodology will modify the data requirement for the calculation of performance scenarios. Instead of the current 5-year performance data requirement, the maximum of 10 years or 5 years more than the product’s recommended holding period (RHP) will be used.

Then, the RTS will modify how unfavorable, moderate and favorable scenarios are computed. Breaking away from simulations based on daily returns, this new methodology will take the worst, median and best evolution of the product’s real performance in a sub-interval of time corresponding to the RHP. No changes are expected for the stressed scenario methodology, but it will not be more optimistic than the unfavorable scenario. In the article here you can see how the methodological changes for performance scenarios compilation look in practice.

Regarding costs, one key requirement is that the simplified transaction costs methodology known as “New PRIIPs” will be extended by 3 years until 31 December 2024 for UCITS funds. Another requirement is that  total transaction costs might not be lower than explicit transaction costs, making it impossible to observe negative transaction costs. This issue often occurs within the current regulatory framework, due to either the arrival price methodology for implicit costs, or high anti-dilution proceeds.

Even if a more prescriptive method is added to the implicit transaction cost compilation of over-the-top (OTC) derivatives with the arrival price, the new regulation provides flexibility through different options based on bid-ask data availability.

Finally, the reduction in yield has been simplified to take a 1-year period without one-off costs amortization and performance.

The new RTS prescribe that financial market participants should publish the fund’s past performance, analytics that were part of the UCITS KIID document. However, authorizing the publishing of this information in the PRIIPs KID would require a change to the PRIIPs Level 1 regulation, which has not happened. This means that the fund industry must choose between displaying this past performance on a dedicated page of their website, or producing a separate document to the PRIIPs KID.

A new rule also requires the manufacturer to compile and publish all past performance scenarios on their website monthly. This will likely cause confusion, as the performance scenarios displayed on the KID may vary from the performance scenarios on the website. This is because KIDs do not need to be published monthly; instead, only if the (moderate) performance scenario fluctuates by more than 5%.

On a positive note, the new RTS foresee the possibility of reusing some information that is already included in the UCITS KIID’s “Objective and Investment Policy” section, as well as some changes in the costs and performance scenario tables.

The new RTS will also simplify the performance scenarios. If a product’s RHP is less than 10 years, the manufacturer will only need to provide the product’s performance and costs information after 1 year and at the end of the RHP. The intermediary period data will no longer be required.

A major change is also coming for multi-option products. These include insurance-based investment products, for which the cost tables must show a clear distinction between costs induced by the insurance product against those induced by the underlying investment options.

The changes that the RTS impose on the PRIIPs KID will also affect the European PRIIPs Template (EPT) data files. As a reminder, these data files are not a regulatory requirement. Instead, they are imposed by market participants, such as insurers or distributors, who require PRIIPs data from asset managers to complete their own PRIIPs reporting obligations. Considering the same deadline applies to all financial participants, it is worth considering that insurers may require asset managers to send their revised EPT files for testing and preparation purposes before the new RTS go-live date.

Other factors that complicate the game

Along with the new PRIIPs requirements imposed at the European level, there are several national obligations that manufacturers must consider when distributing across borders, specifically with the UK and Switzerland. In the UK, the HM Treasury announced on 1 June 2021 that the current UCITS exemption from the PRIIPs regulation would be extended until the end of 2026.

This means that, as of January 2023, UCITS marketed in the UK will need to produce both PRIIPs KIDs in the EU and UCITS KIIDs in the UK until 31 December 2026. Maintaining both templates could have a significant impact on the costs of producing these reports.

In addition, the review of the UK retail disclosure regime may introduce amendments to the UK PRIIPs regulation or even bring in a new regime. This could lead to the introduction of UK-specific KIDs.

Switzerland’s regulator FINMA requires a KID for each financial instrument registered in Switzerland, the so-called Swiss KID. While the EU PRIIPs KID is considered an acceptable alternative to the Swiss KID, the UCITS KIID is not viewed as such. However, they are accepted for use with products registered in Switzerland until 31 December 2021 to match the end of the exemption of UCITS in the EU originally planned for that date.

Currently, the relevant law does not foresee the possibility of using the UCITS KIID after 31 December 2021, regardless of any extension to the UCITS exemption period. Even though fund associations are expecting FINMA to align these document requirements with the EU exemption period, there is no guarantee this will happen.

Finally, in addition to the European PRIIPs regulation and related national regulations, it is worth mentioning that ESMA issued a set of guidelines on the consistency of marketing and fund documentation in May 2021¹. As regulatory requirements increase around fund documentation, such as the PRIIPs regulation, the Sustainable Finance Disclosure Regulation (SFDR), and the EU Taxonomy, manufacturers must put adequate oversight in place to guarantee their fund documentation is fully compliant, including their prospectuses, KIDs, factsheets and annual reports.

What does the migration entail?

The new RTS changes data requirements and such data is reviewed. Compared with the previous 5 years historical data requirement, financial market participants will need to source longer-term pricing data to reach the maximum of 10 years and 5 years plus recommended holding period and complete it with proxies when the time series is insufficient. They will also need to review the choice of proxies with the prescriptive new guidelines on benchmark selection.

For transaction costs, additional internal bid-ask data of the manufacturer can be sourced to optimize the arrival price transaction costs of OTC derivatives.

The RTS also introduce the possibility for UCITS fund manufacturers to reuse several narratives from their UCITS KIIDs in their PRIIPs KIDs. To benefit from this, manufacturers should conduct a gap analysis of the information that can be reused to identify any data gaps.

Financial market participants must also consider the ability of their data management system and KID system to allow UCITS and PRIIPs data to coexist, if they need to produce PRIIPs KIDs for EU jurisdictions and UCITS KIIDs for the UK. The ability to store both documents and maintain an ongoing review of their content to comply with both regulations will be a major operational challenge.

Interestingly, several asset managers have started considering streamlining the technology and/or providers they use for different report types (KIDs, KIIDs, EPT, the European MiFID Template [EMT], factsheets, and on their website), not only to improve their cost efficiency but also to ensure the consistency of data and statements across the board and comply with regulations.

Manufacturers should also start tackling the requirement to publish past performance scenarios and data. Regarding the past performance data, they need to decide whether to use a separate document annexed to the KID or a digital publication on their website. No clear market trend has yet emerged regarding this publication.
Last but not least, the application delay of the new RTS to January 2023 will force UCITS manufacturers to perform a final UCITS KIID annual update in February 2022, while also working on the migration to PRIIPs KIDs. These two major events are sure to put pressure on organizations.

Organizations must put a well-structured data management framework in place during this period to ensure all changes introduced in the UCITS KIID annual update are properly reflected in the PRIIPs KID under preparation.

References

¹ ESMA, Final Report - Guidelines on marketing communications under the Regulation on cross-border distribution of funds, 27 May 2021.