Response to joint Discussion Paper on Key Information Documents (KIDs)
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The question “Is risk and return balanced?” should be considered carefully: an answer to this question by the entity which originates the PRIIP could be influenced by subjective considerations which do not match the investor’s, who would be able to compare different PRIIPs exclusively on the basis of objective risk/return considerations.
We also believe it could be useful to add a reference in the section of the KID entitled “What are the risks and what could I get in return?” to the relevant section in the offering documentation, to allow investors to obtain more detailed information on the types of risk attributable to the main risk types referred to above related to the individual PRIIP.
In general terms we feel that the method chosen to represent the risks should be consistent with the representation of the performance scenarios, in line with our response to Q6.
Our idea is to always report each additional risk factor, as source of contingent costs potentially borne by the investor.
The performance scenarios for the return on the proposed product, where necessary, should therefore: (i) be based ONLY on objective and deterministic criteria (the “what-if” scenario), not on statistical calculations of probability or possibility; (ii) show only the return on the PRIIP in relation to the performance of the underlying instrument (in the three traditional scenarios, i.e. positive, neutral and negative).
b) In general, to really offer a high degree of qualitative information in each KID, single cost items reported in Table 12 for structured products shall also highlight breakdown costs charged by the structurer/issuer (with a model standard to the industry) versus costs charged by the distributor. This because one product can be issued by a Company and distributed by a multitude of players, each one charging different costs: since the KID must be put in place for the entire product life, this is a very important element to be cleared and addressed.
c) On the basis of point b), another issue arises because of the obligation imposed on the “structurer” to keep each KID up-to-date. Since each product has several distributors, the obligation on the “structurer” has a conceptual and operating limit on the information validity of the KID. The KID must be prepared by the distributor.
d) For structured products, the most flexible valid approach for costs indicators is “Reduction in Yield”, since the other two approaches can be actually applied at the “issuing stage” and never in the secondary market. Indeed, once a structured product is issued, it will include, on an ordinarily basis, market bid-ask spread.
- from a theoretical point of view, the issue of integrating risks or even only part of the risks is still being disputed;
- the advantages in terms of simplification and transparency would be negligible; whereas a single indicator would entail the risk of investors being unable to distinguish which risk factor out of the three included (market, credit and liquidity) is most relevant, making it difficult for them to choose between different PRIIPs with the same aggregated risk level and pursue their own risk-weighted investment objectives;
- the weight of each of the three risk factors can vary depending on the structure of each product;
- as mentioned before, also different risk factors can be linked to some financial products included in the scope of application of the PRIIPs regulation.
In short we would advocate representing the risks separately.
b) In general, to really offer a high degree of qualitative information in each KID, single cost items reported in Table 12 for structured products shall also highlight breakdown costs charged by the structurer/issuer (with a model standard to the industry) versus costs charged by the distributor. This because one product can be issued by a Company and distributed by a multitude of players, each one charging different costs: since the KID must be put in place for the entire product life, this is a very important element to be cleared and addressed.
c) On the basis of point b), another issue arises because of the obligation imposed on the “structurer” to keep each KID up-to-date. Since each product has several distributors, the obligation on the “structurer” has a conceptual and operating limit on the information validity of the KID. The KID must be prepared by the distributor.
d) For structured products, the most flexible valid approach for costs indicators is “Reduction in Yield”, since the other two approaches can be actually applied at the “issuing stage” and never in the secondary market. Indeed, once a structured product is issued, it will include, on an ordinarily basis, market bid-ask spread.
In order to ensure uniform conduct, it is therefore vital that the ESAs provide clarifications and guidance in the draft RTS both of the general scope of application of the regulations, as well as the correct interpretation of recital 18 to the Regulation, which adds a further level of specification compared to the general category.
Assessment of whether or not changes are “material” should therefore works along similar lines to those used by the issuer at the stage of placement or admission to listing on a regulated market, to establish whether or not a supplement is necessary to the offering documentation.
2: Do you agree with the description of the consumer´s perspective on risk expressed in the Key Questions?
It seems to us that the width of risks covered by the Key Questions on the whole may be considered as adequate to represent the consumer’s risk perspective. It is important in particular to pay careful attention to the series of questions relating to the time horizon envisaged for the investment (“How long should I hold it?”), because different objectives could alter the projected risk/return, not least and above all in case of PRIIPs providing for payoffs when the PRIIP itself expires.The question “Is risk and return balanced?” should be considered carefully: an answer to this question by the entity which originates the PRIIP could be influenced by subjective considerations which do not match the investor’s, who would be able to compare different PRIIPs exclusively on the basis of objective risk/return considerations.
We also believe it could be useful to add a reference in the section of the KID entitled “What are the risks and what could I get in return?” to the relevant section in the offering documentation, to allow investors to obtain more detailed information on the types of risk attributable to the main risk types referred to above related to the individual PRIIP.
3: Do your agree that market, credit and liquidity risk are the main risks for PRIIPs? Do you agree with the definitions the ESA’s propose for these?
In general terms we would agree that market, credit and liquidity risk are the main risk factors to be represented to the customer in the majority of the cases. However, these risk factors are not the only ones that might be relevant for all the PRIIPs. In addition, it should also be borne in mind that such three main risks might not be relevant for all PRIIPs covered by the proposed key information document.4: Do you have a view on the most appropriate measure(s) or combinations of these to be used to evaluate each type of risk? Do you consider some risk measures not appropriate in the PRIIPs context? Why? Please take into account access to data.
While we do agree that the three risks indicated in the Consultation Paper are relevant for customers, we have also stated in our response to Q3 above that such risks might not apply equally to all PRIIPs. We also believe that a set of purely qualitative metrics might be the best way to describe the risk to customers, given the variety of products involved. The reasons for this chiefly relate to the possibility of offering to the customer simplified information which is easier to interpret/compare, thus avoiding possible elements of subjectivity in implementing quantitative metrics, based on methodologies that do not represent standard market practices (pricing models, time horizon for generating loss scenarios, availability of like-for-like historical series, etc.). Furthermore, although the quantitative metrics proposed reflect concepts which are familiar in the finance world, they might not be readily comprehensible for a retail investor.In general terms we feel that the method chosen to represent the risks should be consistent with the representation of the performance scenarios, in line with our response to Q6.
5: How do you think market, credit and liquidity risk could be integrated? If you believe they cannot be integrated, what should be shown on each in the KID?
Correlated to what answered to question 19, there is no way to indicate an exact amount in Reduction in Yield to address information about contingent costs. As reminder, the case of liquidity scarcity impacting the product secondary in the immediate post-Lehman period can give an exact idea of what can happen in very contingent cases.Our idea is to always report each additional risk factor, as source of contingent costs potentially borne by the investor.
6: Do you think that performance scenarios should include or be based on probabilistic modelling, or instead show possible outcomes relevant for the payouts feasible under the PRIIP but without any implications as to their likelihood?
The introduction of probabilistic scenarios would require a completely different information profile from those referred to in the Regulation. Hence the introduction of such scenarios is neither necessary nor helpful, as it would not guarantee to the investor any better information, only a potential expectation based on risky, probabilistic evaluations not governed by the existing regulations surrounding the financial markets. It should also be borne in mind that probabilistic quantification of a scenario is usually obtained on the basis of risk free pricing considerations, whereas it would be more advisable to provide assessments based on real-world considerations. This kind of probabilistic quantification is also dependent on choices made in terms of modelling which are linked to (but not only) the calibration and availability of market data.The performance scenarios for the return on the proposed product, where necessary, should therefore: (i) be based ONLY on objective and deterministic criteria (the “what-if” scenario), not on statistical calculations of probability or possibility; (ii) show only the return on the PRIIP in relation to the performance of the underlying instrument (in the three traditional scenarios, i.e. positive, neutral and negative).
7: How would you ensure a consistent approach across both firms and products were a modelling approach to be adopted?
Evaluation of the issuer should be based on standard models of issuer risk classification, such as assessment of rating (information which is already contained in the offer documentation), among other things to avoid duplications in terms of information based on potentially different assumptions which could create confusion and disorientation on markets and among investors.16: What are the main challenges you see in achieving a level-playing field in cost disclosures, and how would you address them?
a) Table 12 should also include funding risk, possibly in the “Market impact costs” box, as this can be highly impacting in periods of funding scarcity (as it was in the post-Lehman period, when prices of banking product had been highly impacted by no interest of banking treasurers in unwinding underlying funding positions).b) In general, to really offer a high degree of qualitative information in each KID, single cost items reported in Table 12 for structured products shall also highlight breakdown costs charged by the structurer/issuer (with a model standard to the industry) versus costs charged by the distributor. This because one product can be issued by a Company and distributed by a multitude of players, each one charging different costs: since the KID must be put in place for the entire product life, this is a very important element to be cleared and addressed.
c) On the basis of point b), another issue arises because of the obligation imposed on the “structurer” to keep each KID up-to-date. Since each product has several distributors, the obligation on the “structurer” has a conceptual and operating limit on the information validity of the KID. The KID must be prepared by the distributor.
d) For structured products, the most flexible valid approach for costs indicators is “Reduction in Yield”, since the other two approaches can be actually applied at the “issuing stage” and never in the secondary market. Indeed, once a structured product is issued, it will include, on an ordinarily basis, market bid-ask spread.
27: In terms of a possible breakdown of costs, are you aware of cost structures for which a split between entry or exit costs, ongoing costs, and costs only paid in specific situations or under specific conditions, would not work?
In line with our comments regarding the diversity of PRIIPs and qualitative measurement of the three risks above, we would recommend not integrating the three risk components, because:- from a theoretical point of view, the issue of integrating risks or even only part of the risks is still being disputed;
- the advantages in terms of simplification and transparency would be negligible; whereas a single indicator would entail the risk of investors being unable to distinguish which risk factor out of the three included (market, credit and liquidity) is most relevant, making it difficult for them to choose between different PRIIPs with the same aggregated risk level and pursue their own risk-weighted investment objectives;
- the weight of each of the three risk factors can vary depending on the structure of each product;
- as mentioned before, also different risk factors can be linked to some financial products included in the scope of application of the PRIIPs regulation.
In short we would advocate representing the risks separately.
29: How do you think should cumulative costs be shown?
a) Table 12 should also include funding risk, possibly in the “Market impact costs” box, as this can be highly impacting in periods of funding scarcity (as it was in the post-Lehman period, when prices of banking product had been highly impacted by no interest of banking treasurers in unwinding underlying funding positions).b) In general, to really offer a high degree of qualitative information in each KID, single cost items reported in Table 12 for structured products shall also highlight breakdown costs charged by the structurer/issuer (with a model standard to the industry) versus costs charged by the distributor. This because one product can be issued by a Company and distributed by a multitude of players, each one charging different costs: since the KID must be put in place for the entire product life, this is a very important element to be cleared and addressed.
c) On the basis of point b), another issue arises because of the obligation imposed on the “structurer” to keep each KID up-to-date. Since each product has several distributors, the obligation on the “structurer” has a conceptual and operating limit on the information validity of the KID. The KID must be prepared by the distributor.
d) For structured products, the most flexible valid approach for costs indicators is “Reduction in Yield”, since the other two approaches can be actually applied at the “issuing stage” and never in the secondary market. Indeed, once a structured product is issued, it will include, on an ordinarily basis, market bid-ask spread.
31: Do you consider that the criteria set out in recital 18 are sufficiently clear, or would you see some merit in ESAs clarifying them further?
The wording contained in the Regulation does not allow products falling within the definition of PRIIPs contained in it to be clearly identified, or even which PRIIPs would qualify as difficult to understand within the meaning of recital 18.In order to ensure uniform conduct, it is therefore vital that the ESAs provide clarifications and guidance in the draft RTS both of the general scope of application of the regulations, as well as the correct interpretation of recital 18 to the Regulation, which adds a further level of specification compared to the general category.
33: Are you aware of classifications other than by legal type that you think should be considered?
We feel that the classification of PRIIPs by legal type is sufficient to provide the investor with simplified information which is easy to interpret/compare.49: Do you agree with the measures outlined for periodic review, revision and republication of the KID where ‘material’ changes are found?
Revision of the KID can result in it showing an asymmetry in information terms versus the offering documentation. It is therefore to be hoped that the requirement to update the document refers only to residual cases, and that the main guidelines for requiring such revision follow the criteria set forth in the Prospectus Directive and serve for the purpose of allowing the investor to understand and/or evaluate the instrument properly.Assessment of whether or not changes are “material” should therefore works along similar lines to those used by the issuer at the stage of placement or admission to listing on a regulated market, to establish whether or not a supplement is necessary to the offering documentation.