The drama and uncertainty of the UK’s referendum result to leave the European Union (EU) has inevitably distracted numerous financial institutions, and rightly so. Fund managers should be in the early throes of analysing their contingency plans for Brexit and reassuring their investors, particularly those in the EU, that they are doing so.
But it is also important to remember that the UK will remain a member of the EU for at least two years, and probably longer while exit negotiations unfold. One of the first acts of the UK Financial Conduct Authority (FCA) following Brexit was to remind financial institutions that their compliance obligations with EU rules still stood irrespective of the vote’s outcome. Nowhere is this more important than the Packaged Retail and Insurance-based Investment Products (PRIIPs) rules, which take effect from December 31, 2016.
The deadline for PRIIPs implementation – coupled with the fall-out from Brexit – will be challenging for affected fund managers. PRIIPs will apply to retail-orientated entities such as structured products; insurance linked products and investment funds including UCITS, although the latter has been granted a five-year transition period. The rules require impacted organisations to supply on a timely basis a Key Information Document (KID), an investor reporting document of no more than three pages which must be straightforward and easy-to-understand that has been mandatory for UCITS managers since the passage of UCITS IV.
This is all part of the regulatory agenda to enhance investor transparency. Retail-orientated alternative investment funds (AIFs) have never been obliged to file a KID, and this could prove challenging initially. However, as with all regulatory reports such as Annex IV or Form PF, firms will eventually get used to the obligations and build streamlined processes or outsource to the relevant service providers to enable compliance. UCITS managers reading this are most likely scratching their heads asking why this is relevant to them. If they are already providing KIDs, why would PRIIPs have a meaningful impact?
PRIIPs’ KIDs must contain details on performance, product complexity and information on the product, costs and risk. A Summary Risk Indicator (SRI) must also be incorporated into the KID on a one to seven scale with seven being the highest risk. Calculating the SRI can be quite complicated. The PRIIPs’ KID and UCITS’ KID are similar in many areas, but there are subtle differences hence why KID reporting for UCITS has been grandfathered. The methodologies and calculations behind some of the data supplied by PRIIPs’ KIDs are not necessarily in complete tandem with that of UCITS’ KIDs. This obviously has recipe for misunderstanding. For example, this could result in investors with exposures to the same UCITS receiving KIDs that do not necessarily possess identical risk calculations.
Perhaps the most controversial aspect of the PRIIPs’ KID has been the insistence by regulators that managers disclose anticipated future returns across three market scenarios. Anticipated returns in unfavourable, favourable and moderate market conditions must be supplied to investors. This obviously exposes managers to legal risk, if they supply information on anticipated returns that fail to materialise, particularly in volatile markets. This is an area of notable concern which needs to be rectified.
Furthermore, many UCITS have devoted scant attention to their PRIIPs’ KID obligations due to the five-year grandfathering clause. This needs to be reviewed as any UCITS managing insurance assets will have to provide those investors with data. This is to allow insurers to create KIDs by the end of the year. Lawyers acknowledge they have not heard of any UCITS supplying PRIIPs in their entirety to insurance clients, but they are building up procedures and processes to supply the relevant data. Affected firms should be liaising with their service providers and general counsel about this.
Critics point out that PRIIPs’ KIDs will bring complexity and additional workloads for fund managers although some point out the added transparency will help enable competition to flourish. Nonetheless, it is crucial firms start executing their PRIIPs’ strategy as soon as possible, while UCITS managers must assess whether or not they are excused from immediate reporting.