The path of the Packaged Retail and Insurance-Based Investment Products (PRIIPs) regulation hit a significant bump in the road late last year, just months before its implementation deadline.
PRIIPs is part of a package of measures introduced by the European Union in response to the fallout from the global financial crisis, and designed to ensure that retail investors properly understand the risks and likely returns from their investments. It aimed to illustrate this understanding through scenarios showing different outcomes in different economic and market conditions.
However, European policymakers rejected several of PRIIPs’ key elements, pushing the deadline back 12 months to January 2018 to allow for revisions to the controversial regulatory technical standards. With recent updates to the technical standards, what questions remain?
PRIIPs Deferred to 2018
PRIIPs regulation had been scheduled to come into force at the end of 2016. However, the deadline was deferred following the decision by the Committee on Economic and Monetary Affairs (ECON) to reject the regulatory technical standards of the key investor documents (KIDs). The main point of controversy was the use of “future performance scenarios.”
The information contained within KIDs were intended to be in-depth and precise, so that retail investors could readily compare the risk and reward characteristics of individual products. But with such a vague goal, problems were inevitable. For example, in multi-option products the treatment of costs can prove problematic because the costs may change in different scenarios. Insurance companies felt disadvantaged by the complex rules governing risk calculations.
There were also problems with products containing derivatives (e.g., futures, swaps) as they are not transparent and the risk profiles and costs may be very different in different market environments. Non-exchange-traded products are difficult to fit into the relevant risk and reward buckets.
Further concern has been directed to the various regulations treating costs differently. Will firms have to derive costs one way for PRIIPs, but differently for MiFID?
The future performance simulations on fund literature have created the most intractable problems. Fund managers had long suggested that abandoning past performance in favor of “future scenario” indications could be misleading. In September 2016, ECON rejected the performance methodology, having concluded it was flawed enough that it could cost those impacted money. With the recent communication, the existing performance scenarios stay, and an additional “stress” scenario is added. This change is to ease previous concerns expressed to provide investors with a more comprehensive view of the possible outcomes by including a significantly unfavorable scenario.
While the performance scenario section is improved, noticeably absent is any information on actual historical performance.
In spite of the delay to PRIIPs, the industry will need to continue as if it is still happening. Those with a patchwork of processes, on an ill-fitting network of spreadsheets, will need to be wary.
The key, as always, will be objectivity and standardization. The regulatory situation is imperfect, but the industry must work with the tools they have, until clarity is provided.