The important PRIIPs regime has had another difficult year in 2020. This ambitious regulation came into force at the start of 2018 (at the same time as its cousin MIFID II) and applies to all packaged retail investments issued in the EU. The date of January 2022 has been looming for some time with double importance. This is the point at which UCITS funds will be co-opted into its scope and also when an expected revamp of some of the PRIIPs rules should take effect. This would make it the most significant milestone since the regime came into force.
Consultation and review process
By way of preparation, in October 2019 the European Supervisory Authorities (ESAs) put forward a public consultation paper. These addressed various “Level 2” technical detail matters. Submissions closed in January 2020 and the responses were subsequently made public, with the revised proposed rules expected in the spring of this year.
With the impact of Covid-19, 2020 has since turned out to be a year like no other and has been an obvious distraction and hindrance to regulatory progress. Urgent matters took precedence and the timetable of the necessary discussion and drafting of rules was inevitably delayed. The ESAs did not report back until 20th July, some four months later than expected. They replied with a digest of the responses to the consultation and their intended changes, along with a full re-draft of the RTS. However, crucially, the letter sent to the Financial Stability Services and Capital Markets Union (FISMA) also explained that the ESAs could not reach internal agreement about their own proposals. This is an unusual position representing a stalemate in further progress. No further update has been made publicly since that time.
Overlapping regulatory turfs
The fundamental problem is one of regulatory turf. PRIIPs, MiFID II and UCITS are all trying to occupy overlapping jurisdictions. PRIIPs is the one effectively playing catch-up as the last of the three to be fully formulated. The idea for PRIIPs came after the financial crisis of 2008, to help prevent investors being sold investments that were too risky or expensive. It is undeniable that some major mistakes have been made along the way in terms of direction, intent and co-ordination.
One obvious deficiency is that PRIIPs and the relevant part of MiFID II were not kept in lockstep while they were developed along similar timelines for their simultaneous going live date. For example, the document that the ESAs had drafted in July talks about the PRIIPs reduction in yield (cost calculation) being “not considered to be consistent with MiFID II”. Given that investments and firms are subject to both regimes (MiFID II has a far wider scope), such a situation is deeply unsatisfactory and had been allowed to develop for many years.
UCITS wagging its tail
While mismatches with MIFID are an issue, it is the presence of UCITS that is the major roadblock. Providing a KIID for a UCITS fund became a mandatory requirement in 2012. Its scope is restricted primarily to fund investments and it comprises a risk indicator, past performance up to ten years, and a relatively simplified cost disclosure. In the funds world, the KIID has got a very good reputation as being fit for purpose, useful as a simplified standardised document but very readable and investors know what to expect from it.
The ESAs did a very thorough job in analysing the feedback from the consultation and presenting proposals. How to better deal with performance scenarios and showing cost calculations were among the key technical questions and both were discussed at length. Of these two, how to present performance is by far the stickier issue.
Further down a dead end path
The proposals made try to address some of the deficiencies, but essentially walk further down a path that has had many critics since the European Parliament’s original rejection of the RTS in 2016. This resistance does not appear to be going away. For example, the ESAs now want to redefine the unfavourable and favourable scenarios with worst and best outcomes of any five years’ worth of performance in a ten year period. Ingenious and not without merit though this is, it does create more complications and scope for inconsistencies.
Alongside the risk rating, and cost calculation the UCITS KIID shows a single table of actual past performances over up to ten years. The ESAs believe that the “Level 1” intention of the European parliament is to replace this past performance with multiple scenarios to give some idea as to different outcomes. The legacy of the financial crisis motivates attempts to quantify the range of future returns.
It is this fundamental shift which has created fault lines ever since. Any set of scenarios or outcomes are by definition arbitrary and it is very easy to find many examples of results that do not make sense across the whole universe of different products, underlyings and time points. It is also difficult to convey the scope of such scenarios and to avoid the idea that they can represent forecasts. The ESAs themselves fell into this trap by analysing the results of performances this year across the COVID crisis. Different scenarios must calibrate to the likelihood of different outcomes, but they are not forecasts.
So this is the impossible position that the industry finds itself in. The regulators felt they wanted to present a range of outcomes in a simplified document ,but this has caused problems and resistance from the important fund lobby, who feel that their KIID serves its purpose well and that the migration they need to do is not being properly managed.
A complete rethink is likely to be needed to unblock PRIIPs from its current position. Is there the political will and technical nous to do so?
A version of this article has also appeared on www.structuredretailproducts.com