Almost 10 years in the making, the PRIIPs Regulation aims to encourage efficient EU markets by helping retail investors to better understand and compare the key features, risks, rewards and costs of different packaged retail investment and insurance based products (PRIIPs) through access to a Key Information Document (KID).
Here, Gowling WLG's regulatory experts give an overview of UK implementation of the regulation, its scope and key provisions, and the potential fines individuals and companies can expect if there is a breach.
The PRIIPs Regulation is an EU Regulation, which means it will apply directly in the UK without the need for any domestic implementing legislation. As a result, the UK has limited policy discretion in how the provisions of the PRIIPs Regulation take effect. However, it will require changes to certain disclosure and information requirements in the Financial Conduct Authority (FCA) Handbook in order for the UK to become compliant with the provisions in the PRIIPs Regulation.
The FCA acknowledges there is limited guidance at EU level on the PRIIPs Regulation and that this may lead to practical difficulties with implementation and uncertainty. To date, the European Supervisory Authorities have issued Q&As on the PRIIPs KID. The Association of Investment Companies (AIC) also issued guidance in September 2017 for investment companies (available to subscribers).
The scope of the PRIIPs Regulation is wide. It applies to anyone that:
- manufactures (or changes an existing PRIIP, including altering its risk and reward profile or the costs associated with an investment in a PRIIP);
- advises on; or
PRIIPs to retail investors in the EU/EEA. This captures fund managers, stockbrokers, financial advisers and intermediaries, insurance companies, investment firms, credit institutions and retail investment product providers.
What are PRIIPs?
The definition is wide and covers a broad range of products and structures.
PRIIPs are investment products, where the amount repayable to the retail investor is subject to: (i) fluctuation because of exposure to reference values; or (ii) the performance of one or more assets that are not directly purchased by the retail investor.
Examples of PRIIPs include:
- regulated collective investment schemes, including non-UCITS retail schemes, qualified investor schemes and individually recognised overseas schemes. UCITS schemes are PRIIPs, however they must comply with the PRIIPs Regulation with effect from 31 December 2019 (rather than 1 January 2018);
- unregulated collective investment schemes (which may also be alternative investment funds) including some unauthorised unit trust schemes, venture capital trusts and private equity funds;
- other alternative investment funds which are not collective investment schemes, such as investment trusts and other listed onshore and offshore investment companies (including REITs structured as alternative investment funds);
- structured investment products, including debt securities where the amount repayable is subject to fluctuations; and
- securities issued by certain SPVs with variable returns.
This list is intended to be indicative only and is not exhaustive.
What products are not PRIIPs?
- investment funds dedicated to institutional investors only (since they are not for sale to retail investors);
- assets (such as corporate shares or bonds) held directly by the retail investor; and
- products where the rate of return is fixed in advance for the entire life of the product.
What are the obligations on PRIIPs manufacturers?
A PRIIP manufacturer (or any other person who changes an existing PRIIP, including altering its risk and reward profile or the costs associated with an investment in a PRIIP) must:
- prepare, and keep updated, a KID for each PRIIP that they produce; and
- publish each KID on their website.
The KID should be reviewed every time there is a change that significantly affects (or is likely to significantly affect) the information in the KID. This could include a change of investment manager, a change to the investment policy, a change to the investment management charges or performance fee, the withdrawal of any buy-back facility provided by an investment company, or the failure to pass a continuation vote.
When must a KID be provided to a retail investor?
Anyone who makes available a PRIIP to a retail investor must provide the retail investor with a KID in good time before any transaction is concluded.
Where the retail investor initiates the transaction by means of distance communications, the KID may be provided after the conclusion of the transaction, subject to certain conditions.
What is a retail investor?
A retail investor is any investor who is not a professional investor - e.g. is not any of the following:
- an entity that is authorised or regulated to operate in financial markets (banks, insurers, investment firms, funds, institutional investors, etc.);
- a large undertaking that meets specified quantitative tests relating to balance sheet, turnover and own funds/employee numbers; or
- an elective professional client that meets specified quantitative and qualitative tests.
This list is intended to be indicative only and is not exhaustive.
Implications for investment companies
Shares issued by investment companies are likely to be PRIIPs. Investment companies therefore need to identify which entity is the 'PRIIP manufacturer' and therefore must assume responsibility for preparing, providing and publishing the KID for retail clients.
Both the FCA and the AIC consider that the alternative investment fund manager (AIFM) of the investment company would be able to prepare the KID for an investment company. Indeed an AIFM will often be considered the 'PRIIP manufacturer' and the entity that makes available the PRIIP to retail clients.
However, it is possible for the investment company itself to be the 'PRIIP manufacturer' (even when it has appointed an external AIFM), where the investment company remains responsible for its own marketing and has suitable governance arrangements in place independent of the AIFM (such as a board of directors). In such cases, the investment company would be responsible for preparing, providing and publishing the KID for retail clients.
The AIC considers that any investment company security that is available on a secondary market is 'made available' to retail investors and will require a KID. This means that the PRIIP manufacturer (i.e. the AIFM or the investment company) must prepare, provide and publish the KID on its website. It will also need to review, and update, the KID every time there is a significant change relating to the PRIIP.
The KID must be prepared for each class of share issued by an investment company which is traded on a public stock market. It is unlikely that a KID is required for a dividend re-investment plan.
Key provisions on KIDs
A KID is a stand-alone document (no more than 3 sides of A4) that provides retail investors with simple and comparable information on the nature, risks, costs and potential gains and losses of a PRIIP. The KID must be fair, clear and not misleading. It must be written in a concise manner and in language that is clear and succinct.
Format and contents required
The PRIIPs Regulation is prescriptive on format and content. The KID must contain the following information in the following order using the template set out in Annex I of Commission Delegated Regulation (EU/2017/653):
- General information. Description of the PRIIP, including the identity of the PRIIP manufacturer and its regulator.
- What is this product? Description of the main features and nature of the PRIIP, including its name, its objectives and how these are to be achieved, its target investor and its term.
- What are the risks and what could I get in return? Description of the risk and reward profile of the PRIIP by using a summary risk indicator - the rules provide for seven classes of market risk and stipulate the methodology for assigning each PRIIP to one of those classes. Indication of the possible maximum loss and four appropriate performance scenarios, representing:
- a stress scenario;
- an unfavourable scenario;
- a moderate scenario; and
- a favourable scenario.
- What happens if [name of the PRIIP manufacturer] is unable to pay out? Indication of whether the retail investor may face a financial loss due the default of the PRIIP manufacturer (or another entity) and whether the loss is covered by an investor compensation or guarantee scheme (and any limitations of conditions to that cover).
- What are the costs? Description of the costs associated with an investment in the PRIIP using a summary cost indicator. The rules set out the methodology for calculating the costs - one-off, recurring and incidental. Costs must be expressed in both percentage and monetary terms.
- How long should I hold it and can I take money out early? Description of the recommended and, where applicable, required minimum holding period, any cooling off or cancellation period and all applicable fees and penalties and consequences of cashing in before the end of the term or recommended holding period.
- How can I complain? Information about how, and to whom, a retail investor can make a complaint about the PRIIP or the PRIIP manufacturer, adviser or distributor.
- Other relevant information. Indication of any additional information documents to be provided to the retail investor at the pre-contractual and/or the post-contractual stage (excluding any marketing material).
For complex PRIIPs, a "comprehension alert" must be included in the KID stating: "You are about to purchase a product that is not simple and may be difficult to understand".
A product is regarded as not being simple and as being difficult to understand if:
- it invests in underlying assets in which retail investors do not commonly invest;
- it uses a number of different mechanisms to calculate the final return of the investment, creating a greater risk of misunderstanding on the part of the retail investor; or
- the investment's pay-off takes advantage of retail investor's behavioural biases, such as a teaser rate followed by a much higher floating conditional rate, or an iterative formula.
Responsibility for accuracy of KIDs
The PRIIP manufacturer is responsible for ensuring the accuracy of the KID. A retail investor may be able to hold the PRIIP manufacturer liable for an infringement of the PRIIPs Regulation where he or she suffers damage as a result of reliance on a KID:
- that is inconsistent with pre-contractual or contractual documents under the PRIIP manufacturer's control;
- that is misleading or inaccurate; or
- where the KID does not comply with prescribed format and content requirements.
Sanctions for breach of the PRIIPs regulation
The FCA will be responsible for supervising compliance with the PRIIPs Regulation in the UK.
The FCA may issue a PRIIP manufacturer, adviser or distributor with an order:
- prohibiting the marketing of the PRIIP;
- suspending the marketing of the PRIIP;
- prohibiting it from providing a KID that does not comply with the PRIIPs Regulation; or
- requiring it to publish a new version of a KID.
Individuals are liable to fines of up to:
EUR 700,000 (or equivalent amount) or twice the amount of profits gained, or losses avoided, because of the breach.
Companies are liable to fines of up to:
EUR 5 million (or equivalent amount) or up to 3% of its total annual turnover or twice the amount of profits gained, or losses avoided, because of the breach.
PRIIP manufacturers, distributors and advisers should now be putting into place the measures necessary to comply with the requirements of the PRIIPs Regulation. The new rules take effect on 1 January 2018.
Key areas of focus
- Scoping - identifying whether a product is a PRIIP within the scope of the PRIIPs Regulation and identifying the PRIIP manufacturer;
- Collating data - understanding the data requirements for the KID and the complex methodology that must be applied when calculating risks and returns and costs;
- Preparing the KID - producing a KID for each PRIIP and ensuring it fully complies with the PRIIPs Regulation;
- Website - setting up a webpage on the PRIIP manufacturers' website that is dedicated to KID publications and kept up-to-date;
- Monitoring and updating - establishing processes to ensure the KID is reviewed on both a regular and ad-hoc basis and kept up-to-date;
- Distribution - reviewing and updating agreements with distributors, advisers and intermediaries vis-à-vis their obligations and liabilities under the PRIIPs Regulation; and
- Complaints handling - establishing an effective complaints procedure.