This week, the FCA published the findings of its Call for Input on the PRIIPs regulation. What do the findings say, and do they have any concrete actions for Compliance teams?
Why is the PRIIPs regulation causing concern?
The Packaged Retail and Insurance-based Investment Products regulation came into force on 1 January 2018. It aimed to extend the standards of consumer protection introduced by MiFID II to insurance-based investment products. At the time, we identified PRIIPs as one of the headline events for Compliance teams in 2018.
One of its key requirements was the need for firms to produce Key Information Documents (KIDs). They are designed to make it easier for customers to understand and compare retail products, by standardising the information they receive – for example, on costs and performance.
However, concerns about these KIDs were behind many of the negative headlines PRIIPs generated in 2018.
In July last year, the regulator asked firms to share their experience of complying with PRIIPs as part of its work to respond to concerns. The findings released this week are the results of this exercise.
What are firms’ experiences in complying with the new requirements?
The FCA’s Call for Input sought to gather experiences from ‘those who are producing, advising on, or distributing PRIIPs (and preparing and providing KIDS), and consumers now using KIDS’.
In particular, the regulator wanted to know about:
- Problems with clarifying the scope of the PRIIPs regulation.
- The calculation of transaction costs, which are required as part of the KID.
- The presentation and calculation of ‘performance scenarios’ in the KID, which are intended to indicate the level of returns a consumer could expect from a product in different market conditions.
- The presentation and calculation of the ‘Summary Risk Indicator’ (SRI) and description of other key risks in the KID, which should provide a consumer with an overview of the main risks associated with a product.
The Call for Input generated 103 responses from firms, trade bodies and consumer organisations.
What issues did the research identify?
- Issues around the scope of the regulation.
Firms are uncertain whether PRIIPs applies for certain types of investment, with corporate bonds identified as a key concern. Many issuers and brokers are avoiding offering retail bonds to negate potential compliance risks.
- Issues around Summary Risk Indicators.
Firms fed back that the Summary Risk Indicator (SRI) – a scale designed to express the product’s market risk and credit risk – appeared to deliver lower risk ratings than expected if the underlying or reference asset is illiquid. There were also concerns that the SRI is viewed as an indicator of overall investment risk of the product, when in fact it just relates to price volatility, and is therefore potentially misleading; there are also other risks, which may be more significant, but are not captured in the SRI.
- Issues around performance scenarios.
The responses showed ‘significant concerns’ that the current methodology for presenting performance scenarios produces ‘misleading illustrations across almost all asset classes’. A number of responses stated that performance scenarios for alternative investment funds and investment trust companies are ‘very misleading’.
Conversely, some issues the regulator was expecting to see flagged were not highlighted as major issues. In the Call for Input, the FCA highlighted concerns that some KIDs were displaying transaction costs that were unrepresentative of the true cost of the product. This was not borne out by the research. The FCA has therefore concluded in this case that poor application of the PRIIPs methodology was the cause of the cases it had seen.
What is the FCA doing to address the issues identified?
- Scope of the regulations: the FCA is engaging with the European Commission and the European Supervisory Authorities (ESAs) to share the evidence received. The regulator stated that it would ‘strongly support EU-level clarifications on the scope of the PRIIPs regulation for corporate bonds’.
- Summary Risk Indicators: the regulator is discussing the issues with the Commission and the ESAs to ensure that the SRI accurately represents the risks of illiquid PRIIPs
- Performance scenarios: the FCA says that it ‘shares respondents’ concerns about misleading performance scenarios’. Following work with the ESAs, the regulator contributed to the ESA Consultation Paper published in November 2018 and is continuing to push for a solution at an EU level.
- Transaction costs: as the regulator’s believes that this is due to poor application of the PRIIPs methodology, rather than issues with the methodology itself, it plans to ‘work with market participants to increase understanding and ensure compliance with the PRIIPs legislation’.
- This work includes seminars, and could in future involve ‘more detailed investigations into specific firms, individuals or practices’. (If this is something you’d like to be ready for, you might like to read our guide on how to prepare for an FCA visit.)
What happens next?
The regulator will progress the work outlined above to identify ways to tackle the issues firms are facing. The report says that the FCA ‘will continue to work closely with the ESAs and the Commission through 2019, subject to the nature of the UK’s relationship with the EU’.
It also acknowledges that the regulator has ‘significant concerns about potentially conflicting requirements or lack of clarity about scope of application of PRIIPs requirements’.
The FCA will look at how domestic guidance on interpreting the rules might help to mitigate its concerns about performance scenarios, SRIs and the scope of the PRIIPs legislation overall.
While the regulator addresses these issues, you can read our advice on avoiding some of the potential pitfalls in preparing your KIDs.
How can we help?