PRIIPs: Recommended Holding Period has been saved
PRIIPs: Recommended Holding Period
Recommended Holding Period in the new PRIIPs RTS context
PRIIPs manufacturers ought to define a Recommended Holding Period, or RHP, to display in the Key Information Document and use in various calculations.
European Commission Delegated Regulation concerning Packaged Retail and Insurance-based Investment Products (or PRIIPs) is live since January 1st, 2018. It encompasses all products, regardless of their structure, where the amount payable to a retail investor can fluctuate due to the performance of assets not directly purchased by said retail investor.
One of the concepts introduced by the PRIIPs regulation is the “Recommended Holding Period”, or RHP. Within the Key Information Document (or PRIIPs KID), a whole section entitled “How long should I hold it and can I take my money out early?” is dedicated to disclose this RHP, a number expressed in years. The manufacturer of the product describes in this section the reasons for selecting the particular RHP and impacts of cashing-in early, in terms of risk, early exit penalties or applicability of capital guarantees.
While the PRIIPs regulation was originally designed to make investment products more transparent, industry experts have raised several fundamental issues with its prescribed methodologies, in particular for the performance scenarios compilation and transaction costs computation.
In response, the European Commission has published in 2021 amendments to the the RTS addressing a few methodological points. For the overview of all the changes as well as points you need to know for successful migration to the new RTS , you can read more here.
Also, you can read more here about the identified challenges with the 2017 RTS methodology for performance scenarios, and how the methodological changes look like in practice.
Previously, many were critical of the performance scenarios because of how the recent trends in the market have been greatly exaggerated when projected over longer recommended holding periods, as you can see in the illustrative example below. Now, in the amended regulatory technical standards, the recommended holding period is directly involved in determining the length of the historical data to be considered for the computation of the performance scenarios.
By contrast to the PRIIPs regulation, the UCITS regulation does not require any explicit specification of the investment horizon, except for a simple mention in the “Investment policy” section of the KÌID. Similarly, MiFID II regulation allows for less granular definition of investment horizon using descriptive phrases. On that matter, PRIIPs shows more prescriptive and detailed than other regulations. In turn, the RHP plays an important role in the calculation of multiple metrics displayed in the KID and with the new RTS, also influences the data requirements for the computation of the performance scenarios..
The choice of RHP by the PRIIP’s manufacturer is thus crucial. It results from a difficult trade-off between various factors, e.g. the nature of the product, the specific profile of the investor it is intended for, and the market practices for similar products.
Recommended Holding Period – observed market practices
Market view on the Recommended Holding Period
Deloitte’s analysis based on a representative sample of more than 31.500 share classes, covering all investment strategies, shows that more than 60% of the share classes are using the 5-year horizon as the RHP.
In the 2017 version of the Regulatory Technical Standards supplementing PRIIPs regulation (and prior), the 5 years recommended holding period is used as an illustrative example, which may explain why some PRIIPs manufacturers are using 5 years as a ‘default’ value.
Furthermore, some PRIIP manufacturers might be relying on the descriptive investment horizon (e.g. from the MiFID Target Market). This figure can then be translated into a unique figure for the PRIIPs purpose using the EWG’s EMT guidelines, where medium to long-term investment horizon corresponds to 5 years.
Recommended Holding Period impact on Data requirements
In the new PRIIPs RTS, the historical data requirement for unfavourable, moderate and favourable performance scenario computation* has been altered to try to more accurately represent the future performance. The old rule called for ideally 5 years of price history, but in many cases and depending on the valuation frequency, less data was sufficient.
Now, the regulator calls for historical data for a length of the maximum between 10 years and the recommended holding period + 5 years.
This may be challenging for newly launched funds, or when it comes to computing the data for long holding periods such as those disclosed in the Comfort European PRIIPs Template (CEPT). The data gap can be closed using proxies, however this may results in more expensive market data acquisition.
*this change concerns unfavourable, moderate and favourable performance scenario, while the data requirements for stress scenario remain unchanged
Various PRIIPs metrics impacted by the choice of the RHP
Recommended Holding Period impact on Market Risk Measure (MRM)
In theory, RHP is one of the variables entering into the market risk calculations, in particular the VaR-equivalent volatility (“VEV”) compilation. However, our analysis shows that once the RHP is greater than one year, the effect on VEV (and henceforth on MRM), becomes negligible.
In the example of the illustrative fund in the graph below, even increasing the RHP to 100 years did not move VEV sufficiently to fall into another MRM bucket. In particular, the VEV fluctuates between 6.16% and 6.02%, while the MRM 3 covers VEV between 5% and 12%.
However, we recommend paying special attention to the cases where the VEV is very close to the bucket limit, as the small changes can affect the final SRI.
As can be seen on the graph above, the biggest impact is observed for the RHP below 1 year – in that case, the risk increases substantially. This is in line with what we intuitively expect, i.e. the short horizon implying greater level of risk.
Recommended Holding Period impact on Credit Risk Measure (CRM)
According to the PRIIPs methodology, the computation of the CRM takes also the RHP into account. In practice, this adjustment increases the credit quality if the RHP is less than one year, and decreases the credit quality when RHP exceeds twelve years. Since the vast majority of PRIIPs have an investment horizon comprised between one and twelve years, the CRM adjustment is again non-material. Below is the table showing how PRIIPs RTS recommends adjusting the credit quality step (finally mapped onto CRM) to reflect the recommended holding period of the investment (from RTS, Annex II, point 42.)
Recommended Holding Period impact on performance scenarios
Let us first consider the impact of RHP on the unfavourable, moderate and favourable performance scenario. The new methodology requires that performance scenarios be calculated using data sampling of RHP lengths.
From this, the best value is set to be the favourable scenario and the median one to be the moderate scenario.
In case the RHP is greater than one year, additional sampling of the historical data is performed.
One must now take overlapping intervals of increasing length from one year to the recommended holding period, starting from the compilation date.
Their performances must now be made comparable using a linear transformation, and then the worst out of both the first and second data sample is set to be the unfavourable performance scenario.
To illustrate how this works in practice, we’llve also prepared a step-by-step illustrative example in the coming weeks.
The holding period impacts the stress scenario in that it can affect which volatility and quantiles are used when computing this particular metrics. However, once we move past 1Y, these factors remain constant, thus limiting the impact of the RHP.
Recommended Holding Period impact on time horizons for performance scenarios
The recommended holding period selected is a sole determinant as to which time horizons will be disclosed in the PRIIPs KID. The new PRIIPs RTS has removed the need for intermediate performance scenario for products with RHP below 10 years, moving the threshold from 3 years previously.
Another impact of RHP in the compilation of performance scenarios occurs when RHP is less than one year. In such case, the displayed returns should not be annualized but cover only the recommended investment horizon. Below is the comparison of the two ways to display returns for an illustrative fund with RHP of 3 months following the performance scenario methodology as prescribed in the the “old” 2017 RTS.
Recommended Holding Period impact on Reduction in Yield (RIY) and total costs
Following the same principle as the performance scenarios, PRIIPs KIDs display the RIY at various points in time, based on the RHP. In particular, RIY tends to decrease over time. This is no surprise, since the effect of one-off costs tend to be diluted on a longer period of time. On the long run, RIY tends to converge to the sum of recurring and incidental costs.
The effect was even more observable in the table ‘Composition of costs’, showing the impact each year of different types of costs on the investment return an investor might get at the end of the RHP.
The amortization was making it difficult for retail investors to assess and compare the costs they were exposing themselves to. This point has been addressed in the new PRIIPs RTS, which prescribes disclosing all the items in the ‘Composition of costs’ table (now both in € and % terms) over one year.
The tables displayed are only to illustrate the impact of RHP on PRIIPs figures and should not be relied on or used for any other purpose.
In April 2019, the European Supervisory Authorities (ESAs) published additional Q&A on the Key Information Document for PRIIPs, including a new question under point 4. in “General Topics” about various aspects to be be considered when determining the RHP of a PRIIP. ESAs highlight that while PRIIPs manufacturers should take into consideration the minimum required holding period and/or a maturity date, it may or may not coincide with the recommended holding period. They further underline that the manufacturers should focus on advising a time horizon for the targeted retail investor by considering the fundamental structure of the product, such as risk and reward profile, capital guarantee mechanism, cost structure and even tax implications. In case of multiple viable holding periods, ESAs recommend this be reflected in the section “How long should I hold it and can I take my money out early?”.
PRIIPs Reporting Services
Our PRIIPs KID Factory and Reporting services
PRIIPs: Performance scenarios
Performance compilation methodology and identified challenges