On December 31st, 2016 the Financial Industry will go live with PRIIPs regulation. The regulation will introduce the Key Investor Document (KID), a maximum 3-page document, written in plain language that must be shared with all retail investors before they enter into a contractual agreement on any Packaged Financial and Insurance based product.
Of course, such documents are not new to the UCITS Fund Industry. Back in 2011, a similar document – the Key Investor Information Document (‘KIID’) – was introduced under UCITS IV. The European Commission has duly taken this into account and has granted a 5-year grandfathering period for the KIID before deciding on its future.
In principle, therefore, this should give the Fund Industry a degree of breathing space before adopting the new KID document. However, how will investors react when faced with the Distributor presents them with two different documents? Granted, both documents are similar. But they are not identical
Here are seven points to consider, which might prompt you to act sooner than later.
1. Back to the Future
Unlike the KIID, the KID will change the way that investment rewards are represented. The notion of potential future rewards and maximum losses on invested capital will now be required in the KID. Although it is entirely feasible to suggest that documenting past performance scenarios for funds will remain, in our view Risk and Performance teams will have to increase their contribution when putting together the new KID document, given the emphasis that will be placed on guiding investors on the fund’s expected future performance.
2. Show me the Risk
A heavily debated argument in the UCITS KIID has been the use of a Synthetic Risk Reward Indicator (SRRI). ESMA concluded that a number from one to seven, based on the volatility of the fund, would represent a common denominator to express the risk that could easily be understood by the retail investors. As the KID will be applicable to a variety of financial instruments, the challenge for the regulators will be to find a common approach in order to come up with a unique summary risk indicator; one that works effectively across a number of different risk categories. It is expected that the balance of the risk components does not disadvantage any type of instrument.
3. TER 2.0…?
PRIIPs regulation will require going further with respect to cost disclosure. Indeed, the ongoing charges should encompass all fees, including those related to transactions and performance. This represents a whole new set of challenges for the asset servicers as a new TER method will have to be put in to practice.
4. Don’t overlook MiFID II
We believe that PRIIPs should not be looked at in isolation, especially with respect to MIFID II. Admittedly, this Directive has been postponed for another year but it is still worth noting that when it does get transposed into European law, MiFID II will deal with many topics including the strengthening of investor protection through new responsibilities in terms of product governance.
At this stage, manufacturers are still exploring how to cope efficiently with these new responsibilities. If the regulation will not allow for an early opt-in option for the UCITS KIID, the industry needs to be prepared that a review of the current UCITS KIID is most likely and that it will be in its best interests to make the document MiFID II compliant.
5. Distributors wanting both
Considering the fragmented intermediation of the distribution chain, the industry faces a real challenge with respect to passing on PRIIPs-related information and documentation. Moreover, it’s worth asking onesself the question of whether distributors will put pressure to obtain both KIID/KID documents for UCITS funds, as this would ease the job considerably on their side.
6. Avoid Mass Production Headaches
Another challenge of PRIIPs relates to the production of the documents. If the quantity of documentation for the UCITS KIID seemed formidable, the sheer mass of documentation that will need to be produced for the KID will be orders of magnitude higher. Although it is nearly impossible to evaluate the number of documents that will need to be produced, considering the percentage of revenues within the financial industry stemming from structured retail products one has a good indicator of the substantial number of instruments issued.
7. Prepare to Customise
We need to acknowledge that many structured products are tailor-made and produced on the spot with real time data. This is a completely new world, especially for KIID producers.
PRIIPs regulation is a big step towards establishing a unique level playing field among investment products. The fund industry has long called for this, especially as transparency requirements and heavy regulations imposed on them have been challenging for them up till now. Many actors within the fund industry have, however, so far paid little attention to PRIIPs because of the five-year grandfathering exemption period for the UCITS KIID.
Although many implementation details are still up in the air, the industry should not sit back and wait. Rather, it should start proactively defining its strategy and structuring an effective implementation path for PRIIPs. As is often the case in this industry, first movers often tend to be the winners!