On 11 November 2015 the Joint Committee of the European Supervisory Authorities1 published a joint Consultation Paper in relation to draft regulatory technical standards with regard to PRIIPs Key Information Documents (the “draft RTS”)2.
The draft RTS relate to three Articles under the PRIIPs Regulation3 namely:
- the presentation and content of the Key Information Document (KID), including methodologies for the calculation and presentation of risks, rewards and costs within the KID4;
- the review, revision and re-publication of KIDs5; and
- the conditions for fulfilling the requirement to provide the KID in good time6.
The draft RTS contain various Annexes which, amongst other things, contain a template for the KID and the proposed methodologies underpinning the presentation of risks, rewards and costs.
Comments on the Consultation Paper are requested by 29 January 2016. Once feedback is received on the Consultation Paper, the RTS and accompanying impact assessment will be submitted for endorsement by the European Commission by 31 March 2016.
This article looks at the Consultation Paper in further detail, and highlights various issues raised by the draft RTS with a particular emphasis on retail structured products such as notes, warrants and certificates linked to various asset classes. We intend to release a separate article highlighting various issues specifically with regard to investment funds in due course.
PRIIP manufacturers must prepare and publish KIDs for each PRIIP they manufacture by 1 January 2017 and, from that date, those selling or advising on PRIIPs must provide KIDs to retail investors. The ultimate aim of the KID (once finalised and implemented) is, in the words of the European Banking Authority, to provide EU retail investors with consumer-friendly information to enable retail investors to understand and compare PRIIPs across the EU, whether offered by banking, insurance or securities firms.
As set out in the summary of the contents of the draft RTS in the joint Consultation Paper, in summary, the draft RTS cover the following:
1. Presentation and content of the KID
The draft RTS provide a specification of the presentation and content of the KID. They address measures for the different elements of the document that are outlined in the PRIIPs Regulation7 itself and the underlying methodologies necessary for obtaining information for the KID. In particular:
They include a mandatory template to be used for each KID, including mandatory text to be used. The template also includes details of the layout that must be followed.
- For the risk and reward section of the KID, the draft RTS require a summary risk indicator that comprises seven classes, the format of which is to follow the template contained in the draft RTS.
- The draft RTS also contain a methodology for the assignment of each PRIIP to one of the seven classes contained in the summary risk indicator, and for the inclusion of narrative explanations and, for certain PRIIPs, additional warnings.
- The draft RTS include requirements on performance scenarios and a format that must be followed for the presentation of these scenarios. These are to be presented in tables, showing the possible performance for different time periods and at least three scenarios designed to represent an unfavourable scenario, a moderate scenario and a favourable scenario. There are also requirements on the selection of these scenarios by the PRIIP manufacturer.
- The draft RTS also contain requirements on the presentation of costs, including the figures that must be calculated and the format used for these. Detailed methods are included for the measurements and calculations needed for completing the prescribed format for each PRIIP. The cost figure includes a standardised summary breakdown of the different cost components, aggregated cost figures and a presentation of the accumulation of the costs in monetary and percentage terms for standardised period(s).
- The draft RTS set out the specific layouts and contents for the KID for products offering multiple options that cannot be effectively covered in three pages.
2. Review, revision and re-publication of the KID
The draft RTS set out requirements for the revision and re-publication of the KID at least once a year, and an obligation to conduct ad hoc revisions, when necessary under the detailed methodologies for calculating the summary risk indicator, the performance scenarios and the costs, and when necessary for products offering multiple options.
3. Providing the KID in good time
The draft RTS set out the requirements for the KID to be provided sufficiently early for a retail investor to be able to take its contents into account when making an investment decision. The timing of the delivery of the KID can vary depending on the PRIIP in question and the needs of the retail investor.
Points for consideration in relation to retail structured products
A. Form of template
To satisfy the KID obligations, a specific form of template must be completed by PRIIP manufacturers8. A pro forma template is set out for this purpose in the draft RTS9, essentially just replicating the items of information already required by the PRIIPs Regulation10.
The pro forma illustrates in physical terms one of the key challenges that lies ahead for PRIIP manufacturers, namely how to satisfy the content requirements of the PRIIPs Regulation within the constraints of a “short document written in a concise manner and of a maximum of three sides of A4-sized paper11. The template alone, which is by definition “unpopulated” with information specific to any product or manufacturer, is two pages long. Given the complexity of a number of products covered by the PRIIPs Regulation and the requirement to summarise characteristics including the objectives, returns, risks and performance scenarios of a product, manufacturers will have to give considerable thought to the production of their KID templates.
It will be essential for manufacturers to strike the appropriate balance between conciseness and comprehensiveness to ensure that they do not leave themselves open to damages claims if the information is “misleading, inaccurate or inconsistent with the relevant parts of legally binding pre-contractual and contractual documents”.12
B. Description of the type of retail structured products
Helpfully, the draft RTS13 state that the type of the PRIIP (such as a retail structured product) specified in the KID shall be “described by reference to the legal form taken by the PRIIP, and, as appropriate, may be supplemented by the classification of the PRIIP as may be commonly used by PRIIP manufacturers to group specific products”. As a result, the draft RTS expressly anticipate that commonly used terms in the market for types of retail structured products, such as barrier reverse convertible notes, can continue to be used to identify the relevant product. This helpful reference must, however, always be considered in the context of the general requirement that the KID must be “accurate, fair, clear and not misleading”.14 Consideration will need to be given to any commonly used terms that may imply a particular result (such as “Twin-Win” products).
C. Performance Scenarios
The draft RTS15 provide that the KID shall contain “appropriate” performance scenarios. This is explained further as consisting of three performance scenarios, setting out an unfavourable performance scenario, a moderate performance scenario and a favourable performance scenario under the relevant PRIIP16. The draft RTS also include the format that the presentation of the performance scenarios should take17. The amounts that may be received under the various scenarios should be described by reference to (i) what an investor might receive after the deduction of costs and (ii) the average return each year, in each case at various intervals during the life of the structured product.
PRIIP manufacturers will need to give careful consideration to the performance scenarios included in the KID. The requirements may initially seem straightforward, particularly in light of the fact that the format the performance scenarios should take is provided in the draft RTS. However, even relatively common structured products may have various permutations and contingent payment structures, both during the life of the structured product as well as at maturity. This could mean that it is difficult to describe the various possible scenarios under the structured product using the prescribed structure in the draft RTS. Examples may include a barrier reverse convertible with periodic barrier assessment points, or a structured product that has a “memory coupon” feature. This is particularly important given the requirement that the performance scenarios must be “presented in a way that is fair, accurate, clear and not misleading”.18
The draft RTS include various provisions governing how the costs to an investor must be disclosed in the KID19. Of particular note for retail structured product manufacturers is the requirement that, for the purposes of the calculation of the implicit costs embedded in PRIIPs, the manufacturer shall refer to the issue price and, after the subscription period, to the price available to purchase the product on a secondary market20.
Structured products distributed to retail investors are often distributed using a variety of different distribution channels and a number of different private banks and other third parties may be involved in the process. As a result, there may be a variety of fee structures in place, and different distributors may charge different amounts for distributing the same securities. Product manufacturers of retail structured products in particular will need to carefully consider what disclosure is made in relation to these costs and how they are ascertained.
E. Frequency of review
The draft RTS provide more detail on the requirements for the periodic review of the KID, but uncertainty remains as to how the requirements will be applied and enforced in practice and what this means for the compliance systems of PRIIP manufacturers.
The information in a KID will need to be reviewed at least annually and a revised KID will need to be published following that review22 (even if the information in the KID remained accurate). This requirement is relatively straightforward, but will represent a significant compliance burden on PRIIP manufacturers, who have generally not been under a requirement to update documentation relating to an individual product after it has initially been issued and sold.
The information in a KID will also need to be reviewed on an ad hoc basis “without undue delay” where the PRIIP manufacturer becomes aware of a change that that affects or is likely to affect the information contained in the KID23. The PRIIP manufacturer must have adequate processes in place to identify, again “without undue delay”, circumstances which might necessitate a review.
It is not clear what would constitute “undue delay” for these purposes. Where a revised KID needs to be published, the requirement to do so without undue delay will need to be satisfied, in any event, within five days24. This may give some indication of the expected timeframes. However, the events leading to an ad hoc review may have material consequences for an investor and therefore have an impact on the accuracy of the KID. For instance, the occurrence of a barrier level/price being breached and the structured product being “knocked out” could result in the investor becoming exposed to negative asset performance and effectively losing the possibility of principal protection on the product.
As a result, PRIIP manufacturers will need to give careful consideration to the systems and processes that they will need to have in place both to monitor the occurrence of events that could have an effect on the information in a KID, and to produce replacement KIDs in a timely manner. This will be necessary to mitigate the risk of claims from investors, or scrutiny from regulators, potentially arising from KIDs becoming out-of-date. Processes by which KIDs can be produced and updated in a timely and efficient manner, perhaps including automated solutions that are integrated with the manufacturer’s own price monitoring and documentation systems, are likely to be a key focus for PRIIP manufacturers.