AMAFI - Association française des marchés financiers
AMAFI generally agrees.
As regards the question “Is risk and return balanced?” AMAFI agrees that the section “What are the risks and returns?” will answer this question.
It should be noted that the comparison between products on these aspects (as illustrated by the follow-up question “Am I able to get this information of other products and I am able to compare this product with other products?”) will be enabled by the risk indicator and cost disclosure (common to all products) and more generally by the use of the KID whose purpose is precisely to allow comparison. This comparison need should therefore not result in additional wording in the KID to reference some other comparable products. As stated by Article 8(2) of the Regulation, the purpose of the KID, which will be inserted directly underneath the title of the KID, is to provide the client “with key information about this investment product”, not to identify other comparable products.
AMAFI agrees that market and credit risks are the main risks to consider to design the risk indicator, whilst the other risks can be described by use of narratives or, for the least important, by references to other documents.
AMAFI agrees with the market risk definition as being the risk of changes in the value of the PRIIP due to movements in the value of the underlying assets or reference values. For structured products, this definition is a good illustration of the delta (and other risk sensitivities of the product).
AMAFI agrees with the definition of credit risk as “the risk of loss on investment arising from the obligor´s failure to meet some/all his contractual obligations”, with the caveat that the obligations referred to are those to repay or deliver to the investor.
Yet, it does not agree that the analysis of the credit risk of the product should comprise the likelihood of each counterparty defaulting and the recovery rate upon default, as the credit risk of the underlying assets would already be included in the market risk of the product. For example, when the PRIIP’s return comes from the credit risk of the underlying assets (as in a credit linked note), this is reflected in the PRIIP´s market risk (a change in the credit risk of the underlying assets will affect the market risk of the PRIIP).
The credit risk of the PRIIP itself hinges on the risk of failure of the issuer, or the guarantor if any, to repay the investor. It is not dependent on the credit risk of the underlying assets, which is accounted for in the market risk.
AMAFI does not fully agree with the definition of liquidity risk as “(i) the absence of a sufficiently active market on which the PRIIP can be traded or (ii) the absence of equivalent arrangements”. The nature of PRIIPs is such that many of them are hold-to-maturity products and that their underlying assets may not themselves be liquid. The existence of an active market is therefore not the natural option for ensuring liquidity on PRIIPS. AMAFI does not agree that the liquidity of these products should be assessed based on concepts pertaining to tradable securities, such as the existence of an active market, market makers or a listing on exchange.
The actual liquidity of a PRIIP is dependent on (i) the liquidity of its underlying assets and (ii) the existence of a contractual commitment to provide liquidity under certain conditions (for e.g. commitment to a maximum bid/ask spread under normal market conditions). This means that liquidity cannot be assessed without considering the liquidity of the underlying assets (for example, if the underlying of a PRIIP is a UCITs fund which provides weekly NAVs, the PRIIP would also offer a weekly liquidity). AMAFI considers that if any restriction to liquidity results from the liquidity of the underlying assets, this should be made clear in the KID.
AMAFI suggests that liquidity should be assumed if (i) a liquidity provider exists (such as the manufacturer or third-party brokers) regardless of whether the product is listed or actually traded and (ii) liquidity is ensured under normal conditions. The commitment of the liquidity provider should be objective (contractually agreed for example).
Finally, for transparency purpose and for the sake of simplicity, the same approach as the one adopted for UCITS should be taken to describe liquidity risk, i.e. using narratives in the two sections of the KID dedicated to liquidity “What happens if the manufacturer is unable to pay out?” and “How long should I hold it can I take money out early?” rather than including it in the risk indicator.
AMAFI considers that, first and foremost, the objectives of the risk indicator should be defined. In its view, the most appropriate measure of market and credit risks should meet the following objectives, consistent with the EUSIPA’s work on key criteria for assessment of a risk methodology:
a) Lead to economically reasonable classifications of products based on their risk/reward profiles, while ensuring an appropriate distribution of products across the various risk classes;
b) Be unbiased toward any type of product;
c) Be transparent, accessible and reproducible to allow external calculation by third parties, including competent authorities – no proprietary methodology;
d) Be applicable to all types of PRIIPs (i.e. funds, insurance products, derivatives, convertibles and structured products);
e) Enable an easy and cost-effective implementation by manufacturers and third party calculation firms. Ease of replication and cost-effective implementation is critical given the number of products in scope;
f) Lead to an easily understandable classification system for the average retail investor;
g) Be objective not to lend itself to manipulation ;
h) Be consistent with the UCITS methodology used for calculating the synthetic risk and reward indicator as set by CESR in its guidelines 10/673. This is to leverage work already done to implement the UCITS Regulation and to ensure that PRIIPs and UCITs are on an equal playing foot.
i) Achieve an adequate degree of stability in the risk classification process with respect to normal trends and fluctuations of financial markets.
Generally speaking, AMAFI considers that a pure qualitative approach is not appropriate for measuring market risk because failing to take into account all factors, it leads to approximates, which often are based on biases towards some products against other products and which often lead to misrepresentations of risk for certain categories of products.
AMAFI shares the view expressed by CESR in its Guidelines 10/673 on UCITS that “volatility is a well-known and well-established concept in finance, a measure conceptually easy to grasp”. The KIID has been a successful achievement driven by ESMA in the UCITS space. Distributors are now familiar with this risk measures based on volatility. Our view is that the same approach should therefore be followed for PRIIPs, with some amendments to cater for the diversity of products concerned. This will ensure PRIIPs and UCITs are on a level playing field, retail investors are able to compare the different investments available to them with similar risk indicators and the transition for UCITS is easier if it were decided that they should comply with the same requirements in five years time.
AMAFI is therefore very much in favor of a volatility based measure of market risk (see in Appendix I AMAFI’s proposed methodology).
Amongst the quantitative measures proposed in the DP for market risk, although Value at risk or Expected shortfall can be used, they have in our view several drawbacks:
- They are not retail friendly, in that grasping probabilities is more difficult for a retail investor than understanding volatility;
- They provide results that lack stability over time compared to an approach based on volatility;
- They are not as commonly used as volatility and would lead to different metrics for PRIIPs that are not UCITs, therefore preventing retail investors from easily comparing UCITS risk with the one of PRIIPs (at least during the transitional period during which UCITS are out of scope of this requirement);
- They use forecasted data which are not easily available, hence lending themselves to a degree of opacity in the choice of data and raising potential cost and computational issues for smaller manufacturers;
- They are model dependent, hence making comparison between different manufacturers’ products difficult;
- They require modeling capacities not available to all manufacturers (especially the smallest), which should not lead to reliance on a few players with proprietary methodologies, creating an oligopolistic position.
As regards more specifically Expected Shortfall VaR (“ES_VaR”), although it is a better measure then VaR in that it represents an average loss for the investor under a given a scenario and not just a single point in the expected distribution of returns, it measures the ability of an investor to bear losses but disregards the upside of the product. Due to instability of 99% ES_VaR, several ES_VaR would have to be considered. For example, if the ES_VaR 99% over the full tenor of the product is 92%, meaning that in the worst 1% of cases the investor loses on average 92% of its investment, this does not give the investor much information and will lead to a binary classification of PRIIPs
AMAFI has conducted a study over an array of products, which shows that the 99% ES_VaR is a “digital” indicator meaning it is either close to 0% for 100% capital protected products or close to 100% for products with no capital protection at all. To obtain better granularity, in case the 99% ES_VaR is greater than 15% (meaning that in the 1% worst cases the average loss is more than 15%), it makes more sense to use the 75% ES_VaR, representative of the average loss in the worst 25% cases: this is representative of more losses scenarios than just the 1% worst case.
The qualitative measures of market risk are subjective by nature hence lacking a solid basis to ensure true comparability between PRIIPS, as manufacturers may have different approaches to assessing them. Most of all, the criteria considered will be covered in some shape or form in the various sections of the KID (mainly the description of risks or performance).
More specifically, AMAFI has the following comments on some of the measures proposed:
- Type of underlying Useful for information purposes but the volatility of the underlying is more relevant than its type (some emerging markets’ underlying may be less volatile at a given time than developed markets’ ones)
- Risk diversification and leverage These measures cannot be qualitative; in our view risk diversification and leverage can only be measured quantitatively.
- Other product design features Relevant features would need to be commonly defined and interpreted by manufacturers. This is more useful as a potential risk warning rather than as a measure of risk.
- Exposure to foreign exchange rates This is also more useful as a potential risk warning rather than as an accurate measure of risk.
AMAFI does not agree with the general statement in § 3.4.2 of the DP that one should consider the product characteristics and not only the general solvency of the manufacturer or the entity responsible for the payment obligations if different.
On the contrary, it agrees with § 3.3.3 of the DP defining credit risk as “the risk of loss on investment arising from the obligor´s failure to meet some/all his contractual obligations” (see AMAFI’s answer to Q3).
AMAFI is not in favor of relying on CDS levels or funding spreads for the following reasons:
- Some product manufacturers may not have a CDS traded in the market but only a credit rating (e.g. Investec Bank in the UK market), funding spreads are usually not publicly available and these may not be available in EURO.
- CDS or funding spreads are often subject to changes (sometimes volatile changes) (when rating agencies classification offers greater stability).
As regards credit VaR, it should be noted that it is model dependant and, as such, not easy to audit by regulators. As a result, it does not offer the best comparability between manufacturers and is not of a common usage, making it difficult to comprehend for retail investors.
Prudential supervision is a good measure, but not sufficient in itself to distinguish between various creditworthiness. In our view, it should be a prerequisite that the guarantor be a supervised entity anyway (as is currently required by the French AMF as regards structured products – see AMF Position n° 2013-12). Another limit is that it is country specific.
Risk spreading is a concept from the UCITS world, which is not transposable to the vast majority of PRIIPs because a PRIIP does not generally “invest” in a diversified basket of assets with different credit ratings while a UCITs fund can do. This measure should therefore be removed because it does not apply to the entire universe of PRIIPS.
The level of seniority and the secured or unsecured nature of the PRIIP would be insufficient and certainly a little obscure for a retail investor. This information could be provided if need be for information only.
Deposit insurance schemes are not applicable to PRIIPs except for structured deposits. As it can not apply to the entire universe of PRIIPS, this measure should be removed.
In AMAFI’s view the best approach to credit risk would be based on one or more of the main rating agencies classification, looking both at short term and long term ratings, because it is objective, can be easily controlled by regulators, provides better stability than a CDS spread, and is usually available to all manufacturers/obligors. The list of eligible rating agencies registered with ESMA is sufficiently broad for this purpose in AMAFI’s view
The approach AMAFI suggests with regard to measuring credit risk is described in Appendix I, section 3.
AMAFI agrees that the bid-offer spread is a measure of liquidity, as can be (but not necessarily) the average volume traded.
The number of market makers is definitely not a good measure of liquidity for PRIIPS because most often, the manufacturer is the sole market marker but yet provides liquidity with tight spreads (for exchange traded products for instance, a maximum bid/ask spread is set by exchanges).
As regards the characteristics of the exit arrangements, the listing mentioned in point (i) is not a good qualitative criterion in itself because a listing does not necessarily ensure actual liquidity.
We agree with points (ii) to (iv) that exit arrangements can be assessed based on the existence of liquidity arrangements, the conditions of the exit price (such as legally binding conditions like liquidity letters) and the existence of a bid-offer spread in normal market conditions.
In our view, the only reliable quantitative measure of liquidity risk is the bid/ask spread of executed trades, as opposed to the indicative bid/ask spread, but this criterion alone is not sufficient to assess liquidity. Other factors need to be considered, which are the existence of a liquidity provider committed to providing liquidity and the liquidity of the underlying assets. These factors are currently often described in narratives. As a result, describing the liquidity risk through narratives seems to us a lot more accurate than through a quantitative liquidity indicator, which cannot incorporate these qualitative factors.
We are not sure what is meant by contingent costs. This wording is not used elsewhere in the discussion paper.
The main purpose of the performance scenarios should be first and foremost to explain how the product works in a pedagogic way. AMAFI believes that education of the investor together with a realistic choice of performance scenarios should be a guide here at the risk otherwise of confusing the investor and making the production of the KID more difficult than necessary considering the sheer volume of the financial instruments in scope.
AMAFI does not think that basing performance scenarios on probabilistic modeling is the way forward, as such approach has several drawbacks, whose main ones are the following:
1. Experience shows that retail consumers often have difficulties in understanding probabilities or percentiles, which makes it quite hard for them to interpret a scenario based on probability.
2. Probabilistic performances may not provide investors with a full view of the outcomes of the product. For example, for a product whose payoff distribution is very concentrated so that the 10% and 90% scenarios lead to a similar outcome, the investor may not be presented an unlikely scenario even though that scenario is important to understand the loss profile of the product.
3. It opens the door to discussions about the assumptions that should be used to compute these scenarios. For instance, using a risk neutral distribution for an equity linked product would not reflect the perspective of investors in equities who rationally invest in this asset class because they believe that equity carry a risk premium. Such equity risk premium would thus have to be incorporated in the model but there are currently no commonly agreed assumptions as to how to calculate it.
4. The use of a Monte Carlo model is not appropriate for asset classes such as credit and fixed income in that it does not provide meaningful results (assumptions on the distribution of the risk of a counterparty defaulting are highly debatable) and may even be not feasible technically because of the lack of data (such as for fixed income products).
5. Scenarios which are model dependent are not easily auditable by regulators.
6. Assuming that manufacturers would agree on a model to compute performance scenarios, model calibration could still differ because of manufacturers’ differing business models and modeling capacities, leading to different outcomes.
The potential value of probabilistic performances is therefore debatable as they may distort competition between PRIIPS by basing comparisons on non harmonised models and may distort the understanding of investors. AMAFI considers that the benefit of this approach is too limited compared to its drawbacks and the costs manufacturers would support to implement it.
On the contrary, AMAFI considers that hypothetical performance scenarios have the major advantages of being easy to understand and providing investors with an exhaustive illustration of the different mechanisms of the product. Such approach does not deteriorate the comparability of products, as the risk indicator will already incorporate the likelihood of the various outcomes and will be computed using a common methodology for all PRIIPs.
To avoid arbitrary choices of hypothetical scenarios by manufacturers and ensure they represent realistic outcomes, level 3 guidelines could be drawn up for each type of PRIIPs. The AMF has published such guidelines in France for structured products (Position AMF n° 2013-13: Guide pour la rédaction des documents commerciaux dans le cadre de la commercialisation des titres de créance structurés) to ensure, amongst other things, that communications about the performance mechanisms used to compute their return are accurate. These guidelines require that:
- the manufacturer disclose the assumptions used to compute each performance scenario and that these assumptions be realistic;
- the internal rate of return (IRR) of the product be displayed for each scenario;
- any cap on the IRR be disclosed.
A similar approach could be taken at European level to ensure consistency amongst manufacturers and products and avoid any misleading communication.
Should a modeling approach be adopted for performance scenarios, the need for consistency would require a common set of assumptions, upon which it is unlikely that the various parties concerned will agree. This approach is therefore likely to raise more issues than it will add value to investors.
The two main issues AMAFI can anticipate are the following:
- An equity risk premium would need to be included in the model for relevant products because a rationale equity investor would invest in equity linked PRIIPs only if they believe that the expected performance outcome is above the risk free rate. Choosing the right equity risk premium will require a consensus among all parties (ESAs, manufacturers, retail investor representatives, distributors).
- Performance distributions are derived from market data and a model. The choice of market data may lead to inaccurate or different estimates. The choice of the model which the manufacturer uses for hedging purposes is at its discretion and tailored to its own situation. It is unrealistic to expect that all manufacturers could agree on the same model for a given type of PRIIPS.
For products with a fixed tenor, it is fundamental that the whole tenor of the product be used to build performance scenarios. Any performance scenarios based on a shorter tenor (e.g. 10 days for a 5 years product) would be an incorrect description of the potential outcomes of the product.
This approach would also be detrimental to comparability, as comparability could be ensured anyhow by annualizing numbers (e.g. internal rate of return, annualized volatility or cVaR corresponding to the average “annual loss”).
AMAFI is therefore in favour of a flexible approach whereby a standardised holding period assumption would be required only for open ended products.
To the extent that some retail investors may not be fully comfortable with percentages, monetary amounts should be provided in the narratives accompanying the graphs or tables illustrating the scenarios (themselves using percentages). The need in the insurance area to express the unit-linked contracts in number of units also calls for the use of numbers rather than percentages.
These monetary amounts could be hypothetical as to the amount invested (for example 1,000 Euros).
AMAFI considers that performance scenarios should be presented net of implicit costs to avoid any misunderstanding by the investor, implicit costs being defined as the sum of costs upon which the manufacturer has control, i.e. the manufacturing costs and the distribution costs when known to the manufacturer (including inducements).
For instance, a structured product offers 100% capital protection plus 100% of the rise in an equity index and has implicit costs of 2% (e.g. 0.5% issuer manufacturing costs for the manufacturer and 1.5% distribution costs for the distributor, covering issuance and administration costs). The same product would offer 110% of the rise in an equity index (instead of 100%) if all costs were set to 0%, meaning that 10% extra gearing in the call option costs 2% to the client However, displaying performance scenarios showing a payoff of 110% would be misleading because it is hypothetical. Instead performance scenarios should display a payoff of 100% principal protection and 100% of the rise in the index, because these are the actual economic performance that the investor will receive. To ensure full transparency, the 2% implicit costs would be disclosed in the costs section.
The below table illustrates the differences between performance scenarios net of implicit costs and gross.
- Implicit costs (i.e. costs affecting the economic pay-out of the product ) / 2% (0.5% issuer manufacturing cost + 1.5% distributor cost ) / 0% (hypothetical)
- Payout for a purchase price of 100% / 100% + 100% of index rise / 100% + 110% of index rise
- Is this the actual economic payoff that the investor will receive? / Yes / No
- [-] / Suitable to display in performance scenarios / Not suitable to display in performance scenarios because it is misleading
Implicit costs should therefore be displayed in the cost section of the KID and should also be taken into account in the performance scenarios shown. The only costs that could affect additionally the performance scenarios would be performance fees if any, which would then have to de disclosed as coming in deduction of the performance shown.
Other costs that do not affect the economic pay-out of the product (typically those direct costs paid directly by the retail client to third parties such as costs of the wrapper, custody costs, brokerage commissions, stamp duties, transaction taxes, advice fees, distribution fees from third parties...) are not under the control of the manufacturer and should therefore not be part of the performance scenarios. These costs are not dependent on the product itself but on external factors and parties, such that they do not pertain to the KID.
For example, the product may be distributed by different distributors with different fee structures or through different wrappers (as a security or as a unit of life-insurance contracts, including contracts with different fees applicable), meaning that for a given product, different costs could apply depending on the way it is sold, which makes it impossible to disclose in the KID. Assuming that the information could be obtained by the manufacturer, which we do not believe possible on a consistent, exhaustive and per product basis, an approach requiring inclusion of all external costs in the KID would result in a different KID for each different distribution/advising/custody situation, i.e. potentially for each client (see also our answer to Q1- point 1) on the same matter).
Hence, these other costs should be disclosed by distributors / custodians, as required by MiFID. As provided for by Article 8(3)(f) of the PRIIPS Regulation, a statement in the KID will indicate that other costs may be incurred, details of which can be obtained by contacting the advisor or distributor.
AMAFI is of the view that simplicity should prevail here, for the sake of the client understanding but also considering the limited length of the KID.
For simple PRIIPS, not based on formula or calculation mechanisms, two scenarios could be enough, thought there is a risk of misinterpretation by the investor, as no comparison with a neutral scenario would be available.
For most PRIIPS, three scenarios are sufficient (negative, neutral and positive), providing the best balance between the limited length of the KID and the necessity to describe sufficient hypothetical outcomes to explain how the product works. A fourth scenario could be added for PRIIPS with additional features when necessary, i.e. when it brings educational value to the KID.
As explained in Q4 and Q5, AMAFI is in favour of a bi-dimensional indicator with two quantitative components, the market risk and the credit risk, possibly coming with a narrative describing the liquidity risk if it is considered that the sections “What happens if the manufacturer is unable to pay out?” and “How long should I hold it can I take money out early?” are not sufficient to inform the investor on the liquidity risk.
This would be the most accurate expression of risks and would enable fact-based investment decisions by investors. Dissociating credit risk, liquidity risk and market risk has also an educative benefit since an investor not necessarily aware of these three risks could then understand the difference between them, or at least its advisor can explain to him these different characteristics and help choose the most suitable product based also on these.
Although a single visual indicator may be enticing for retail investors because of its apparent simplicity, it is not informative enough, as by mixing different notions of risk, it does not offer investors the possibility to discriminate between them, even though they may not value in the same manner the different types of risk. For example, some investors may be more concerned about credit risk and will make investment decision firstly based on the credit risk dimension, while others may prioritize market or liquidity risk. Combining all risks in a single indicator would result in a loss of information, and potentially lead to investment choices not suitable for investors.
Let’s take the example of an investor who is very bullish on equity markets and willing to take a high market risk, but is concerned about the credit quality of the product manufacturer. This investor may select a PRIIP based first on a minimum credit risk. Any summary indicator commingling market and credit risks (taking the mean, the max or any combination of these) will not provide this information.
Another example is a two-year hold-to-maturity product with no liquidity commitment from its manufacturer with low market and credit risks: this product would likely appear more risky than it really is if the risks are commingled and even though the investor is confident that he/she will not need its money early.
A risk indicator is a great opportunity to “rate” or “rank” products based on the 3 key risks discussed in the DP: market risk, credit risk, and liquidity risk. Commingling those risks to produce a single number is over simplistic and, in our view, not consistent with the ESA’s identification of the key risks and the overall objective of PRIIPS which is to empower the retail investor in its investment decision. Presenting a single visual element for risk means that an overall assessment of risk has been made on behalf of the investor, who is therefore not able to weight the different components of risk according to its perception. Such approach would in our view increase the potential for misunderstandings of risks by retail investors.
The indicator already used for UCITS should be leveraged, as it is already known by a sizeable portion of retail investors. It should however be modified to include a second dimension for the credit risk, which could be rated on a similar scale, differentiated via the use of letters (from A to G) for example. This would be illustrated as shown in our answer to Q5.
Again, simplicity is key both to ensure good understanding by investors and scalability for manufacturers considering the number of products in scope and the need to be able to produce a KID in very tight time frames. For instance in some circumstances such as when a product is built for a particular client (private placement), there can be less than one hour between the time a trade idea is discussed and trade execution.
Multi-dimensional performance scenarios such as the example showed in the Dutch financial leaflet (one dimension for investment and another for value) are not easy to understand for retail investors and are therefore very likely to create confusion.
A single visual element for performance scenarios (option B) has the benefit of being solely focused on the product and easier to understand.
Should the product require a multi-dimensional performance scenarios (e.g. the product performance depends on other factors than financial assets, typically the value of regular investments or withdrawals) then our view is that the manufacturer should be allowed, but not obliged, to add a dimension to the performance scenarios.
It is not clear from the DP what would be the purpose of combining the risk indicator and the performance scenarios. It should be noted that no such combination is mandated by level 1, both aspects, though under the same section heading, being tackled separately.
Such approach seems quite intellectual but not very practical as regards the ability of retail investors to understand this combination and the complexity it introduces for the production of the KID.
The risk indicator and the performance scenarios serve different goals. The purpose of performance scenarios is to explain how the product works in different market conditions in a pedagogic way, while the risk indicator is a measure of risk. If the risk indicator is well designed, there should be no need to reintroduce the notion of risk in the performance scenarios.
AMAFI therefore recommends not to “visually combine” the presentation of risk indicators with performance scenarios.
As explained in question 12, AMAFI favors a multidimensional risk indicator (option 3 with only two dimensions – credit and market risks). As regards the presentation of performance scenarios, option B is the most accessible: a simple visual element illustrating different performance scenarios should provide a good focal point for investors.
As regards item 1 of the table “How much will this investment cost”, AMAFI agrees that it is a paramount question. The follow-up question “Are all costs included in the overall costs amount” is also legitimate. In this respect, it should be made clear to the investor that the KID shows all the costs known by the manufacturer but that costs external to the manufacturer, on which it has no control, may be incurred depending on the parties that the investor has chosen to get access to the product (financial advisor, broker, custodian…). As mentioned in Q10, such costs cannot be disclosed in the KID because they are not product specific and are not known by the manufacturer.
Based on the experience of manufacturers and distributors members of AMAFI, the follow-up question regarding the overall cost amount, which relates to a breakdown of costs is unlikely to reflect investors’ concerns: they want to know upfront what will be the overall costs for them and are not generally concerned by the breakdown (for example, the requirement in MiFID I to provide clients with details of costs on request has seldom been activated by investors). In addition, some charging structures may be complex without being detrimental to the investors. For retail investors, it should be more relevant that the manufacturer clearly discloses implicit costs borne by them rather than providing a detailed breakdown of the charging structure, all the more that the KID is limited to 3 pages. It should be noted incidentally that the PRIIPS Regulation (Article 8(3)(f)) does not require such breakdown of costs.
As regards item 2 of the table, “How accurate is the current estimation of the overall costs?”, it should not be a question that investors should ask when reading the KID, as estimates should not be used or at least should be used in a conservative manner so that costs are never underestimated. It is a fact of many PRIIPS that all costs are not known accurately up-front (for example for structured products, they depend on market factors that will be set only on launch date, i.e. after the marketing phase) but at least realistic maximums should be provided so that the information is not detrimental to the client’s decision. Such possibility could be further restricted so that maximums are a sensible reflection of the actual costs by setting a maximum difference threshold between actual costs and maximums.
As regards item 3 of the table “How do the costs develop over time?,” AMAFI agrees with all the consumer perspectives proposed. We believe that a simple table presentation as set in our answer to question 19 addresses the overall cost both on an absolute and annualised basis.
As regards item 4 of the table, the 3 questions below should be addressed in the section of the KID related to early exit, “How long can I hold, can I take my money out early?”:
- Do I have to pay extra costs if I take my money out early?
- If so, how much extra will I have to pay?
- Will I pay more the earlier I exit from the investment?
AMAFI agrees that exit costs, when known to the manufacturer, should be disclosed. Yet, it disagrees with the further two questions.
- How does the product manufacturer calculate what I must pay?
- When I am being charged costs on my investment, how or why are these costs being generated?
Answers to how the manufacturer computes the costs or why are costs being generated would require a level of detail that is beyond cost disclosure and that would not fit within a 3-page KID. Additionally, retail investors’ primary concern is the total amount of fees they may be charged rather than the detailed fee calculation of the product.
Finally, AMAFI agrees with the last question of section 4, “If I have to pay costs other than when I make the investment, what is the frequency or schedule of such payments?”.
As regards item 5 of the table, AMAFI is of the view that the questions proposed are very misleading: “How much of my initial investment remains after cost deduction?” e.g. “How much of my investment is really invested”?
Taking as an example Option 4 p. 67, which displays a “fair-value/invested capital” of 97% (assuming there are 3% of aggregated upfront costs), this presentation is misleading for 2 reasons:
- The investor could think that 97% “fair-value” is an indicative exit value for the product, whereas it is not.
- The investor could also incorrectly believe that its return will be computed on the basis of a capital invested of EUR 970, while EUR 1,000 are invested and final redemption is computed on the basis of the full notional EUR 1000 (for example, in the case of a capital protected product, EUR 1000 x (100% + Performance of the underlying between strike date and valuation date) and not EUR 970 x (100% + Performance of the underlying between strike date and valuation date). For further details, please refer to our answer to Q17 and Q26, Option 4.
As regards item 6 of the table, “How much am I paying for my capital protection in relation to my overall investment?” it implies providing the breakdown of the zero coupon bond price and the other components of the products. AMAFI believes this level of details, although arguably interesting from an intellectual point of view, is irrelevant for the retail investor, as it is complex and the investor’s primary concern is the total amount of fees charged rather than a detailed breakdown between capital protection and other components.
In addition, it is stated page 48 of the discussion paper that the “cost section aims to capture all the costs that subtract from the investment, or impact the performance of the investment”. However, the amount paid for a capital protection is not a direct or indirect cost which comes in addition to the overall amount invested, as this amount is fully embedded in the overall amount invested. It is neither an amount which is deducted or subtracted from the return of the investment. It should therefore be out of scope of the disclosure.
This amount “embedded” in the overall invested amount, corresponds to a specific feature of the product which will differ from one manufacturer to the other, and is not a useful element for investors to compare two identical products offered by two different manufacturers. Investors rather need to know precisely which of these two products with identical features has the highest direct and indirect costs.
The ultimate objective of the cost section is to ensure comparability, especially between identical products proposed by different manufacturers, and not to oblige manufacturers to disclose their own margins or profits. “Costs” are neither “margins” nor “embedded in the purchase price”. The DP goes in our view beyond the requirement set at level 1 to appropriately disclose costs, direct and indirect, which may be added to the overall amount paid by the investors when purchasing a product, so as to ensure comparability between products.
As regards item 7 of the table, AMAFI agrees that most of the questions are relevant. The conditions for reviewing the information contained in the KID, including costs, will be part of the consultation on Article 10.
As regards the question “Will I receive updates on my costs?”, it should be noted that it is not relevant for all types of PRIIPS, as many of them have no running costs, so that the costs disclosed upfront in the KID have been charged once and for all, with no additional costs incurred afterwards.
As regards item 8 of the table, AMAFI believes that its recommended cost presentation set in its answer to Q19 will enable investor to compare products from several perspectives (manufacturing, distribution, total cost and total annualised cost), therefore answering the 2 questions below:
- Is this product more or less expensive than another product?
- Do I have to pay the same costs (e.g. entry or exit costs) for other products?
The last question “If I pay more in costs for this product will I receive a better return on my investment?” cannot be easily answered in a KID, as it will depend on the final outcome of the product which in many cases can only be known after maturity. Usually the higher the costs for a given product, the lower the expected return on investment will be. Yet it is not always true: a product can show total aggregated costs of 20bps p.a. with an annual net return capped at 10% p.a. while another one can have total aggregated costs of 30 bps p.a. with an annual net return capped at 12% p.a.: the second product may actually provide better returns than the first one.
Implicit costs of structured products
We understand that the implicit cost of structured products although not defined formally in the DP, would be either:
(i) the distinction between the investment’s price and the margin/fees that have been incorporated in the price; or
(ii) the difference between the amount received by the manufacturer and the ‘fair value’ or ‘intrinsic value’ of the product.
1) As regards (i), in addition to its reply to Q 15 on item 6, AMAFI would like to qualify the example provided in the DP that “if a manufacturer sells a structured Euro Medium Term Note (EMTN) at 1,000€, he should disclose in the KID that 3% (30€) of the purchase price is a sales commission and 2% (20€) of the acquisition price will be absorbed upfront to recompense the manufacturer for the costs the manufacturer incurs when structuring the note. The result is that 95% (950€) of the acquisition price will be invested in the note: there are 5% costs”
We would like to clarify that (i) in the above example, it should be understood that the return offered to the investor is based or indexed on a nominal amount of 950€ and that (ii), conversely, it does not refer to the situation where a manufacturer sells a structured Euro Medium Term Note at 1,000€ and 1,000€ of the acquisition price is invested in the note (i.e. the return of the note is indexed on a nominal amount of 1,000€).
In addition, it is worth noting that:
- There is no common approach among manufacturers for calculating the fees incorporated or embedded in the acquisition price: these fees depends on various market or credit parameters (notably credit rating and funding needs), which are specific to each manufacturer, so that perfectly identical products would show different fees, which has the potential to confuse or mislead investors.
- In the example above, the embedded fees or margins of the manufacturers are not deducted from the return promised to the investors: disclosing them would potentially mislead investors.
- What is important for investors is to be able to compare two identical products proposed by two different manufacturers, through a disclose of true costs direct or indirect.
To ensure a common application and understanding of the cost section of the KID, the implicit costs should be defined with no ambiguity. It should therefore be made clear that the implicit costs, i.e. the costs embedded in the purchase price, refer to the costs charged by the manufacturer to structure the note and to the distributor’s cost agreed with the manufacturer (if any).
In our view, the cost disclosure should therefore include:
- the issuer manufacturing costs
- the distribution cost
It should be highlighted that implicit costs are not to be deducted because they are already included in the price, the performance scenarios and the estimated returns. The KID should therefore make clear to investors that these costs are already deducted and do not have to be deducted again, opposite to other costs, which are not embedded in the price (this is assuming of course that the option of displaying performance scenarios net of costs is chosen as discussed in Q10).
AMAFI considers that this approach allows for a common application, which is not the case of the fair-value approach mentioned in (ii).
2) As regards (ii), AMAFI disagrees with the ‘fair-value’ or ‘intrinsic value’ approach for several reasons explained hereafter.
RELIABILITY ISSUES WITH IEV/FAIR-VALUE, DETRIMENTAL TO PRODUCT COMPARISON
As stated in the DP, the main limitation of the ‘fair-value’ is that it is based on models and assumptions, which differ among manufacturers. In Germany, the price paid by the retail investor minus the Issuer estimated value (IEV) gives an indication of an overall cost figure of the product. Yet, the IEV depends on the issuer’s own internal pricing models, meaning there are some challenges in achieving consistency in pricing assumptions for comparisons between manufacturers.
This raises the question of the usefulness of disclosing the fair value to investors if that number cannot be relied upon to compare costs between products. AMAFI considers that the inconsistencies in the way the fair value is calculated by manufacturers are a major drawback of this approach and disqualify it altogether.
THE FAIR-VALUE APPROACH HAS BEEN DEVELOPED FOR SHORT TERM PRODUCTS
This approach has not been used so far for longer term products, whereas a longer tenure would amplify the reliability issues mentioned above.
DIFFICULTY OF UNDERSTANDING IEV/FAIR-VALUE FOR A RETAIL INVESTOR
This is an issue that should be considered in conjunction with the difficulty that retail investors may have in understanding the concept of fair value, which constitute another limitation of this approach. The disclosure of distributor cost and issuer manufacturing costs is easier to understand and achieves the same purpose.
The EIV/Fair value approach was originally designed by manufacturers for distributors’ use, not for retail investors and there is no lesson learned or feedback publicly available regarding the use of this approach.
MEANING OF IEV/FAIR-VALUE DIFFERENCES FOR AN INVESTOR
One can also question what relevant information the fair-value brings to investors. A lower fair-value for a product identical to another one is not necessarily explained by higher costs to the investor and therefore a lower performance, as the fair-value will include factors specific to each manufacturer that have no impact on the investor. For example, a product with a fair value of 95%, purchased at 100% can pay at maturity a 4.5% coupon on the amount invested whereas the same product with a fair value of 99%, purchased at 100%, will only pay a coupon of 4% on the same invested amount. The difference in fair-value can be a reflection of the hedging positions of the two manufacturers, or different ways of calculating it. When comparing two products, a rationale investor would not look at the fair value but at the best coupon for a purchase price of 100%.
Additionally, the fair-value is not a tradable price, it is a theoretical price which has no practical reality for the investor.
As a conclusion, the fair value in our view does not bring any relevant information for investor, in absolute terms but also to compare similar products from different issuers.
EIV’S INPUTS AND LIMITATIONS AS REGARDS RUNNING FEES
It cannot be assumed that the difference between the fair-value and the selling price represents the total costs charged even though this is the intention of EIV, because there are some costs that the EIV does not capture correctly.
Parameters used to value a derivative are adjusted to account for the cost of hedging and the fair value includes an estimate of these hedging costs but not an actual number. Some manufacturers may actually receive funding revenue through the issuance of a structured product (representing cheaper funding than it would be achieved in the vanilla bond market). This raises the question of how to compute the funding difference, and whether that difference should be included in the fair-value.
Additionally, the fair-value does not incorporate running costs. For instance, a three year delta-one product offering the total return of a static basket of stocks, issued at 100% with a running fee of 0.2% per annum, would have a fair value on day 1 corresponding to the value of the basket of stocks, i.e. 100%. Since the 0.2% is taken off on a daily basis from the basket value, the fair-value on day one would not correctly account for this running fee. This would be the case for all products whose fees are booked on an accrual basis.
As a conclusion, AMAFI does not think that approach (i) is perfect but approach (ii) is worse because more complex for investors to understand and opening a lot of room for manufacturers’ discretion in computing the fair-value, including in the calibration of parameters used as inputs. In the interest of simplicity and clarity to investors, AMAFI definitely favours option (i).
Cost structure of convertible bonds
If convertible bonds were to be maintained within the scope of the PRIIPs Regulation (see our General comments), it should nevertheless at least be taken into account that the cost structure of these securities is different from the cost structure of other structured products.
Indeed, unlike other structured products which are the result of a manufacturing process, the price of convertible bonds does not embed implicit costs such as manufacturing and distribution costs. Investors purchase convertible bonds at their market price and pay no fees to the distributing bank. The placing fees are paid to the distributing bank by the issuer and they do not alter the value of the convertible bonds.
As a consequence, the section related to the costs of the PRIIP, whichever of the two options proposed in the DP is ultimately chosen by the ESAs, is irrelevant for convertible bonds, as option (ii) is inapplicable for convertible bonds, and if option (i) was to be applied, the implicit costs disclosed in the KID would be 0.
Cost structure of derivatives
The cost structure of a derivative is described as follows in the DP:
- the intrinsic value of the derivative
- a front-end load fee;
- a sales commission; and
- the issuer margin (covering the operational costs incurred by the issuer for structuring the derivative, market-making, settlement costs and the profit of the issuer)
However, the intrinsic value of a derivative is not necessarily the intrinsic value of the option in financial terms, but the cost of acquiring such derivative in the market. This represents the product value but not a “cost” charged by the manufacturer to the client.
We are not sure what a front-end load fee means and are unable to comment on this.
Finally, as the issuer margin covers operational costs related to the manufacturing and “issuance” of the derivative, we are not sure what “sales commission” refers to. It seems to relate to a third party’s remuneration, whereas it is most uncommon as regards OTC derivatives.
The “issuer margin” should be referred to as “issuer manufacturing costs” for consistency with the cost structure of structured products. .
Cost structure of CFDs
AMAFI has no comment on this aspect, as its members are not active on this type of product.
The costs implications of the Regulation on listed derivatives and structured products will be far higher than on funds because of the much higher volume of derivatives and structured products concerned (several thousands for a manufacturer of such PRIIPS versus several tens for a fund manager) and because there is no legacy information document to leverage, whereas funds can built on the existing KII and the automation they have already implemented.
The PRIIPs regulation will lead to substantial costs for structured product manufacturers, and increase the cost of an issuance ticket. As a result we anticipate that issuances for small sizes may drop, and that product offering and flexibility for the retail investor will be negatively impacted.
AMAFI has identified 2 key challenges to ensure a level-playing field in cost disclosure:
1) Availability, consistency, comparability
The first challenge is to ensure that all manufacturers disclose the same types of costs, using the same methodology. Direct costs under the remit of the manufacturer (typically manufacturing fees and sometimes distribution costs) can be disclosed in the KID because the manufacturer has access to this information. It should therefore be possible for all manufacturers to disclose these costs using the same methodology (this should be discussed in the discussion paper that will follow in spring). This is not the case of external costs, which are not necessarily known to the manufacturer and not product specific (see our answer to Q10).
Pursuant to this, it is important that the cost indicator should only include cost information which are:
(ii) under the control of the manufacturer (since the manufacturer bears the legal responsibility of the accuracy of the KID)
(iii) available to ALL manufacturers of a given type of PRIIP
Our view is that the inclusion of the below third party indirect costs, at the level of a single PRIIP (in percentage or absolute terms), if possible at all, would likely be done with different assumptions or inputs from one manufacturer to another:
- brokerage costs
- stamp duties
- advice fees
- sometimes distribution costs
- portfolio management technique costs
- dividend (a dividend is generally a pricing parameter not a cost, at least as regards structured products)
- look-through costs
This would lead to major inconsistencies in the way the cost indicator would be calculated between similar manufacturers or similar products, at the expense of product comparability for investors and a level playing field between manufacturers and products.
2) Cost uncertainty and use of estimates
There are situations where the costs are not known with certainty at the time the product is manufactured (which is the time at which the KID is developed), because:
- the final size of the issue may change between the time the product is designed and the end of the marketing period
- the market parameters change during the distribution period
- the exact distribution fee is set post-hedging
- distribution costs are waived or reduced by the distributor once it has reached a certain amount of subscriptions (reducing the cost per security)
- the issue size is not known until the marketing period closes
- the distribution cost varies depending on the distributor concerned (when there are several distributors of a single product)
In these instances, our view is that the manufacturer can either:
- ensure that the costs charged will not amount to more than a specific percentage of the investment, or
- use estimates (although it should be noted that this option is not possible when several distributors apply different distribution costs).
The second solution is likely to lead to inconsistencies between manufacturers and to inaccuracies; estimates can also be revised up closer to the hedging date of the PRIIP. Hence, the indication of a maximum fee seems to AMAFI the fairest solution for the client, even though ESMA has considered this approach not acceptable in the past.
A maximum fee represents the worst-case scenario for the client who is aware of the highest amount they can be charged. As opposed to using estimated fees, indicating the maximum manufacturing fee in the KID is a strong commitment from the manufacturer, providing it is realistically set: the final cost will either be this maximum or a lesser amount, which would anyhow be in the interest of the client (i.e. the exact final cost is irrelevant somehow or is relevant only to the extent that it would be positive news for the client, not negative ones). We therefore consider that including a maximum amount is not misleading for the client, on the opposite, and should be permitted when the exact costs are unknown. To ensure that realistic maximums are used, this option could be further constrained by a requirement that the difference between actual costs and this maximum be lower than a certain threshold.
First, there is a need to provide a breakdown of implicit costs as “issuer manufacturing cost” and “distribution cost” instead of aggregating these two concepts under “implicit costs”.
The issuer manufacturing costs should be calculated accurately (using maximums when not know precisely upfront) in the same manner by all manufacturers.
Estimates can be used when the costs are not known with certainty upfront but only in a conservative manner to avoid misleading the investor. As explained in our answer to Q16, the disclosure of the maximum cost charged seems more appropriate and fairer to the investor than the use of estimates.
No, AMAFI does not agree. RIY is difficult to compute and difficult to understand for investors. It seems to be suited to products with complex fee structure (fees varying according to investment size, investment term or performance). This approach, because of its complexity, seems disproportionate for products whose fees are calculated on a constant basis.
Our view is that an approach displaying the Total cost per annum, in the spirit of the Total expense ratio (TER) used for funds, is better on several counts:
- It is already used for UCITS, hence known by a portion of investors and allowing comparability between UCITS and other types of PRIIPS;
- It is simple to compute and understand;
- It is annualised, which is good for comparability;
- It includes running costs, which is not the case of the fair value approach (the “fair-value” does not provide information on future costs such as running manufacturing fees or unknown performance fees at maturity, but only information on day 1);
- It is not dependent on a model and assumptions proper to each manufacturer.
AMAFI considers that the TER approach can provide an accurate view of aggregate costs.
A modified TER approach, as explained in its answer to Q 20 and illustrated by the table in its answer to Q19, is the methodology AMAFI recommends.
It is not clear to us what explicit and implicit growth rates refer to. We understand that this question stems from the need to assume forward looking rates of return of the product in order to illustrate the impact of performance fees or path-dependent fees on the PRIIPS.
With this understanding, this issue is not relevant for structured products whose costs are not dependent on growth rates, whose performance rates are based on formulas and whose implicit costs are embedded in the price of the product (hence showing an expected performance net of implicit costs). The only situation in which assumptions will be needed for these products is when performance fees are charged, which is most unusual for such products.
Please refer to our answer to Q19.
AMAFI agrees that a standardized presentation of costs should apply to allow comparability and ensure a level playing field. However, as all products do not have the same costs structure, some sections of the template will show zeros, which is not friendly to investors in terms of presentation.
A challenge is to clearly differentiate implicit costs, already included in the price of the product and its performances, from other costs (usually external to the manufacturer).
Another challenge is that the comparison would be a bit artificial for products with very different holding periods because the products are in fact quite different in nature (a couple of days to 3 years for most of listed derivatives, usually 8 years for life insurance contracts in France, a couple of days to several years for a UCITs fund).
Presentational examples raising objections and reasons for the objections
- Option 1 is not suitable. It does not provide the exact amount of costs and the detail of issuer manufacturing costs and distribution costs.
- Option 3 is not suitable for equity linked products. The annual percentage rate is a concept used for loans only.
- Option 6 is not easy to understand. It does not provide any information about the total annualised cost of the product. Many figures are shown but the purpose of some of the columns may not be clear for retail investors.
- Option 7 is the worst possible option of all the proposed ones. It does not show the fundamental information of the aggregated amount of costs and the figures in percentage terms. A graph also assumes a specific performance scenario. We believe all graphs relating to performance should be part of the dedicated section “What are the risks and what could I get in return?”. It is complex to understand for retail investors and it would be costly to include in all KIDs.
- Options 8 and 9 will definitely confuse retail investors because of the density and amount of information provided. When one looks at it, it is impossible to quickly spot the most important piece of information, which is the aggregated amount of costs on a per annum basis. Associating costs and scenarios is not appropriate in our view because many products have costs that do not vary according to scenarios. Such presentation also uses about half a page, which is too much in light of the limited length of the KID.
- Option 10 shows neither the fundamental information of the aggregated amount of costs per annum nor cost figures in percentage terms. It does not show any breakdown either. It also assumes a variation of costs across time, which is not the case of many PRIIPS. This option may be appropriate for insurance products (because they are long-term products, with, often, no maturity) but not for other PRIIPS. AMAFI is of the opinion that level 2 measures could take a different presentational approach depending on the type of products considered.
Presentational examples that could work
- Option 2 has the benefit of being simple to understand and concise. It does not require an estimation of the amount invested and it also allows comparability between products, because a single number of total aggregated costs per annum is displayed. A 5 year product with total aggregated costs of 5% (1% p.a.) may be seen quite expensive, while its annualized cost is in fact lower than the one of a 1 year product with total aggregated costs of 2% (2% p.a.), hence the need to display cost information on a per annum basis.
- Option 4 could work providing the information on fair value is removed. As explained in Q17, the fair value brings no informational value, is not a basis on which to estimate costs and offers no true comparability. It is also misleading as the investor could think that 97% “fair-value” is an indicative exit value for the product, while it is not, it could also incorrectly believe that the product return will be computed on the basis of EUR 970 “capital invested” while EUR 1,000 are invested.
Under this caveat, the proposed table is accurate and concise. The investor can easily see initial costs, ongoing costs and exit costs as both percentages and monetary figures. We would nevertheless recommend adding 3 columns related to (i) performance fees (if any), (ii) total cost in percentage and monetary terms for the full product tenor, and (iii) annualised cost as a percentage computed as (ii) divided by the product tenor expressed in years.
- Option 5 is both accurate and concise. It would also provide information (if needed) regarding some special features such as performance fees or early redemption fees. It seems to be suitable for insurance products as well.
Options 2 and 5 are AMAFI’s preferred approaches.
No, we are not aware of products for which this would not work, as when some types of costs are not applicable it could be left blank.
AMAFI does not think that these three risks should be aggregated because each of them is independent from the other and summing them up has no meaning as such. Such aggregation, with no explanation of the different contributions of each type of risk, although it can be considered simple and easy to grasp by a retail investor is however misleading, as concepts which are fundamentally different like credit risk and market risk would be mixed together (please also see our detailed answer to Q12 on this topic). This would also not provide the advisor/distributor with appropriate information to help clients in their investment decision.
Our view is that a single indicator could be used with a multidimensional approach so that investors and advisors will be provided with the most accurate information, without too much complexity. This indicator would have two dimensions illustrating the market risk and the credit risk.
This approach would be consistent with the PRIIPS Regulation which states that the KID should focus on key information and especially “whether it is possible to lose capital” (Recital 15), which is mainly dependent on the credit and market risks. Liquidity risk will arise for the investor only in the case where he/she wants to redeem early; it should therefore not be included in the summary risk indicator. As stated in Article 8.3 (d) (i), this indicator does not need to be exhaustive as it must be supplemented by a narrative explanation of the risks which are materially relevant and which it does not adequately capture. As explained in its answer to Q4, AMAFI therefore considers that the liquidity risk should be described as a narrative, possibly along the risk indicator if needed (although the section entitled “How long should I hold it and can I take money out early?” seems better fit for this purpose).
The risk indicator could be displayed as follows: [please see the graph in our answer to Q5 in the attached file, as it cannot be pasted in this cell].
Cumulative costs should be shown as a percentage of the invested nominal or the initial net asset value of the unit or share. It is easy to understand and allows comparability between products.
AMAFI understands that this list is not exhaustive, as it includes only the cost items considered difficult to assess. It notes though that the most important costs that should be disclosed are absent from the table. These are: (i) the manufacturing costs of the issuer (these fees are used to cover operational and regulatory costs related to issuance) and (ii) the distribution costs, when available to the manufacturer.
Having said that, AMAFI strongly disagrees with the breakdown of charges proposed in table 12. As a principle, it believes that retail investors’ primary concern is the total amount of fees they may be charged, and their impact on performance, rather than the detailed fee structure of the product. The investor needs to know the total costs charged. The technical details of how the manufacturer comes up with a manufacturing cost (e.g. market spreads while hedging, regulatory costs of issuance, provisions for model risk…) are irrelevant to the investor.
This table lists items that are not costs but pricing parameters (dividends) or production costs that are not charged to clients as such (portfolio management techniques, costs embedded in pricing parameters) and are embedded in actual costs charged to clients. It also mixes up costs paid by clients and opportunity costs (see description of dividends). Hence several of the items proposed in the table are in our view not relevant and would result in providing details difficult to individualise and too complex to use in the KID.
Our comments below address each of the proposed cost categories separately:
1. Portfolio management techniques
These costs seem to be more relevant to funds than bank and insurance products. When UCITs may come in scope of PRIIPs 5 years after the regulation comes into force, AMAFI agrees that the use of the fund securities for stock lending, repo or collateral purposes, when it represents a risk to investors, should be disclosed in the risk section of the KID/KIID. The cost of these techniques to the UCIT itself is however a production cost not a cost paid by the client and should not be disclosed.
As regards structured products, the ability to use some of the hedging inventory for stock lending or collateral is taken into account in the pricing of the product (e.g. by marking a repo curve on the underlying stocks), and therefore the benefit, if any, is passed on to the client.
2. Implicit costs
To the extent that implicit costs refer to “issuer manufacturing costs” and “distributor cost” (when known to the manufacturer), the manufacturer should indeed disclose them separately. These should not be aggregated under a section ‘implicit costs’ which has no meaning for retail investors.
PRIIPs can be separated into two types when it comes to the impact of dividends:
- Price return products, where the underlying does not re-invest dividends. In this case the manufacturer marks a dividend curve and this is passed back to the client under the form or a lower purchase price of the product (compared to a product where dividends are re-invested or passed on to the investor).
- Total return products, where dividends are either passed on to the investor or re-invested in the underlying or at the level of the product.
In both cases, dividends are not a cost but a pure pricing parameter of the product (passed on via a price decrease to the client in the first case, or re-invested in the second case).
4. Performance fees
Performance fees are not used for the products in scope of AMAFI’s answer – this paragraph seems to be relevant for UCITS only. AMAFI therefore does not comment on this matter.
5. Early redemption costs
Potential early redemption costs should be disclosed in the section of the KID entitled “Can I take my money out early?” because this is where the client would naturally look to find this information. If it is also included in the cost section, then this information would have to be repeated which is suboptimal considering the limited space available.
6. Look-through costs
Look-through costs are independent from the manufacturer and are not under its control. References to the underlying funds of a PRIIPS can be provided to investors so that they can have access the cost information of these funds in the relevant KIIDs.
7. Costs embedded in pricing parameters
Pricing parameters (e.g. implicit dividends, volatility, rates…) are not costs but the manufacturer’s own estimates of specific components it uses when deciding the price at which it can sell the product. These elements do not bring any relevant information to the retail investor. These are usually set according to the hedging techniques employed by the manufacturer of the product, which is not directly relevant to the retail investor. These are production costs which are covered by the manufacturing fee.
8. Portfolio transaction costs
These costs seem to be relevant for UCITS only. Under this understanding, AMAFI does not comment on this section.
Recommended cost presentation
To summarize, AMAFI recommends keeping the cost disclosure simple, accurate and easy to understand by the retail investor, who is primarily concerned with the total fees charged rather than the detailed fee structure of the product.
We recommend providing the following breakdown between (i) the issuer manufacturing costs (these fees are used to cover operational and regulatory costs related to issuance of PRIIPs) and (ii) distribution costs, when available to the manufacturer.
Adding these lead to a single aggregated number representing the total cost over the life of the product, and a total cost per annum computed as the aggregated number divided by the tenor of the product. This approach is therefore similar to the Total Expense Ratio used in the KIID.
The template below assumes a product with a 4 year tenure, with 1% issuer manufacturing fee and 1.25% distribution cost.
- [-] / Manufacturing Cost - Distribution cost (when known) / Performance Fee / Total costs over the product tenor / Total costs per annum
- Percentage (%) / 1% - 1.25% / 0% / 2.25% / 0.5625% p.a.
- Absolute (based on an investment of EUR 1000 ) / EUR 10 - EUR 12.5 / EUR 0 / EUR 22.5 / EUR 5.625 p.a.
These costs are already included in the price, the performance scenarios and the estimated returns displayed in this KID.
AMAFI agrees that ISINs should be used when available to designate the product in addition to its marketing name if any.
The manufacturer’s website could be provided but a specific email address would be better in our view. This should be in addition to the name of the manufacturer. A postal address could also be provided for clients with no Internet access as opposed to a telephone number because there is not necessarily a single telephone number available to answer questions about all types of PRIIPS of the manufacturer.
AMAFI considers that the name of the competent authority should be preceded by the mention “regulated by” in the manufacturer’s section. It does not think that the competent authority website should be added, at the risk otherwise of confusing the investor as to where the information on the product is available and which contact to use.
This identity section would look as follows:
[Product Name ] ISIN: AAXXXXXXXXXX
Manufacturer: [insert name of manufacturer], regulated by [insert name of the regulator],
email@example.com, postal address.
It is correct that there are national divergences in the way structured products are regulated in the EU at the moment, including as regards the potential insertion of an alert in the marketing documents of the products (example of France : AMF Position 2010-05). There is therefore a need to ensure that the circumstances under which such alert should be inserted be clarified to ensure a level playing field. Such clarification should however ensure an equal treatment of all types of PRIIPS and the alert is meaningful for investors. At the root of this matter is the need to clearly articulate what objectives this alert should meet.
In particular, AMAFI is concerned that the second criterion proposed in the DP would actually target all PRIIPS which are derivatives, convertibles and structured products because all of these products use more than one mechanism (i.e. “a number of different mechanisms”) to calculate the final return of the investment. For example, a structured product offering 100% capital protection and the performance (if any) of a basket of shares would have to bear this comprehension alert (providing mechanisms are numbered as currently done by the AMF in France).
Non formula based UCITS would actually be the only PRIIPS not concerned by the alert, which is not appropriate since active management can be as complex as formula based products. This would create an unlevel playing field between PRIIPS which are UCITS and PRIIPS which are structured products or unit-linked insurance. This also is not consistent with the approach currently implemented by the various competent authorities in the EEA.
AMAFI strongly disagrees with the view that using a number of different mechanisms increases systematically the risk of misunderstanding on the part of the retail investor. The retail investor has no better understanding of how a UCITS is managed. What is at stake is the capacity of the investor to understand the risks he/she takes and the market scenario he/she anticipates. But it is not because a product uses derivatives or sophisticated mechanisms to deliver its performance that it has to be labelled as not simple and difficult to understand and be reserved to sophisticated investors: one should think in terms of intelligibility rather than in terms of complexity. Retail investors should not be discouraged to invest in innovative products, as long as they can perfectly understand the risks they take.
An approach based on mechanisms could be envisaged but only when a certain number of mechanisms is reached, as implemented by the AMF. It should be noted however that such an approach is quite onerous in terms of defining what is or is not a mechanism and counting them for each new product. This would likely be construed differently depending on the competent authority and/or the manufacturer, creating legal uncertainty. In any case, it would still create an unlevel playing field between structured products and UCITs.
As regards behavioral biases, a more detailed analysis of what they would cover would be needed for a harmonised implementation, as suggested in the DP.
If no precise criteria can be found to make this alert works properly, then it should apply to all PRIIPS without distinction.
Yes AMAFI agrees. A generic type could also be indicated such as “retail investment product”, complemented by the legal form of the product.
Example for a structured product issued as an EMTN:
Type: Retail investment product, in the form of a financial instrument equivalent to a debt instrument
Existing classifications are not extensive enough to be applied to all types of PRIIPS.
As a principle, AMAFI agrees that financial jargon should be avoided.
However, it is afraid that general principles may not be of great help for manufacturers because this section is one of the most challenging due to its technicality. For structured products, it is hard to see how the pay-off structure could be “explained in a summary format” because it would likely be incomplete, may be misleading for investors and could be quite risky from a legal point of view for the manufacturer. For example, would that mean that the observation dates of the product would not have to be disclosed?
AMAFI considers it is of the utmost importance that template KIDs be developed for each type of PRIIPS to achieve consistency, comparability and legal certainty. This should not be tackled as level 3 measures, but within the RTS. Level 3 measures would be published too late: manufacturers will have already made and financed the necessary developments to produce their products’ KIDs. Templates should be defined in coordination with stakeholders. The issue is not so much which language to use (i.e. prescribed statements) because some flexibility will be needed on this, it is more about how deep/detailed/synthesised the information content of each section can be.
See our answer to Q34: if a KID template for each type of PRIIPS is developed, it will ensure the quality of this section.
AMAFI is of the view that this section should be concise enough so that investor reads it and precise enough to add-value.
This section should indicate that the customer type targeted by the product is a retail investor and should describe the investment objectives and horizons that the product will satisfy, including the main risks of loss that the investor faces. This section should not be a substitute for investor’s suitability test, as other features of the products contained in the KID may need to be considered for suitability purpose, and these cannot be all duplicated here.
As regards the link with the MiFID target market, please see our answer to Q1.
As regards the development of the DP related to PRIIPS that target narrow or very specific developments of certain underlying assets, it is unclear what it refers to and therefore AMAFI is unable to comment on it.
AMAFI agrees with the development regarding the recommended holding period.
AMAFI cannot answer this question, as it does not represent insurance activities.
Some products are considered perpetual but in actual facts they are not really perpetual because they always include a call provision which can be exercised upon notice. Even for these products, this section could therefore be filled in.
The use of the word “scheme” in the DP seems to imply that this section would be dedicated to indicating whether a national deposit guarantee scheme or securities guarantee scheme would apply to the PRIIP.
Leaving aside the case of structured deposits which are covered by deposit guarantee schemes (such as the FSCS in the UK), AMAFI considers that these two types of schemes are irrelevant in the context of PRIIPS because:
- PRIIPS are not deposits and therefore are not covered by the deposit guarantee scheme
- The securities guarantee scheme applies in case of bankruptcy of the client’s account holder, which is unrelated to the product itself, is unknown to the manufacturer, and could point to any EU member State, so that such information cannot be provided in the KID.
AMAFI considers that this section deals with the risk of default of the issuer, so that the role of the guarantor can be explained to the investor. It could read as follows:
“The manufacturer ensures the redemption amount corresponds to the product’s formula. Should the manufacturer default, the investor has a right of recourse with the guarantor YYY in order to receive the amount owed to him by application of the repayment formula.”
The discussion is a correct reflection of the challenges linked to the fact that the manufacturer may not know who the distributor is. Another challenge is that there could be several distributors for one PRIIP, or that the PRIIP could be designed with one distributor originally and then other distributors could join in.
For these reasons, AMAFI agrees that an email address at the manufacturer could be provided and that this should be complemented with a general statement that the investor can contact the entity who has proposed the PRIIP to him, such as the advisor or distributor. AMAFI is not in favor of inserting the contact details of a distributor even if known because there may be other distributors marketing the product or joining later on which would then have been left out. The general statement should be sufficient to direct the investor to the right contact.
AMAFI considers that this section should aim at providing the contact details to lodge a complaint; it should not provide a description of the manufacturer’s complaint process
Yes, AMAFI agrees.
AMAFI is not sure what a PRIIP offering a wide range of investment options is referring to (insurance based PRIIPS ?) and is therefore unable to answer this section.
AMAFI is not sure what a PRIIP offering a wide range of investment options is referring to (insurance based PRIIPS ?) and is therefore unable to answer this section.
AMAFI is not sure what a PRIIP offering a wide range of investment options is referring to (insurance based PRIIPS ?) and is therefore unable to answer this section.
AMAFI is not sure what a PRIIP offering a wide range of investment options is referring to (insurance based PRIIPS ?) and is therefore unable to answer this section.
AMAFI is not sure what a PRIIP offering a wide range of investment options is referring to (insurance based PRIIPS ?) and is therefore unable to answer this section.
AMAFI is not sure what a PRIIP offering a wide range of investment options is referring to (insurance based PRIIPS ?) and is therefore unable to answer this section.
The areas of attention identified in the discussion section are indeed very important.
As a principle, AMAFI considers that the purpose of the KID is not to inform existing investors of any changes occurring after the product has been sold since the KID is a pre-contractual document intended for would-be investors.
The KID should not be a substitute to the duties of the advisor/distributor towards its clients in terms of on-going information to be provided to the investors during the tenor of the product. This means that revisions should happen only in case of significant changes likely to impact significantly existing investors (and not already showing in the valuation of the product that they receive) or likely to change the basis on which potential investors would make their investment decisions.
Under these conditions only, the revision of the KID should entail a republication on the manufacturer’s website. An active approach to client information should not be mandated by PRIIPS because such requirement would impede on MiFID, which regulates the duties associated with investment services. Such requirement is indeed highly conditioned to the type of investment service provided to the client by the distributor/advisor.
In any case, the responsibility for an active approach should sit with the entity that has provided the investment service to the client, which in certain cases may be the manufacturer, but would generally be the distributor. The manufacturer, except if it is also the distributor, will indeed not have a relationship with the end investor and would be unable to make this communication on a personalised basis.
Finally, it should be noted that such obligation would be particularly disproportionate considering the sheer volume of PRIIPS in scope at the level of each manufacturer.
As regards PRIIPs made available to retail investors in a non-continuous manner or closed-ended PRIIPs, the KID being a pre-contractual document, there is no ground to update it and re-assess it if no further agreements will ensue the distribution phase, i.e. if the product does not continue to be sold once issued. It should be noted that these products not offered continuously or closed-ended, do not include only most structured products and closed funds but also OTC derivatives and convertible bonds, the former being negotiated bilaterally at a point in time and hence not open to further purchase and the latter being offered only for a short period of time and being illiquid securities which are not traded on a “secondary market” (see comments under Q. 50 on the difference between the existence of a secondary market and the listing on an exchange). Furthermore, the holders of convertible bonds are grouped within a body through which they are informed of any material changes related to the issuer of the securities.
Changing market conditions and more specifically any change in the risk and reward profile of the product will be reflected in the valuations that the client receives anyhow. The RTS should therefore not impose regular reviews and updates of the KID of non-continuously offered or closed-ended products. The only occasion when it should be reviewed (and potentially updated) is when a request for purchase is received outside of the marketing period AND the conditions described in (i) below (i.e. material changes) are fulfilled. For the sake of clarity, the KID of non-continuously offered or closed-ended products should explicitly indicate the marketing/offering period, for example in the section “What is this product?”.
As regards products continuously available, an annual assessment seems adequate but the conditions under which this assessment should result in an update of the KID should not be defined extensively, at the risk otherwise of having to update the KID of the whole stocks of such products every year (see figures provided in our general comments). This would be extremely costly and uneconomical for manufacturers.
Such update should be made:
(i) On the occurrence of any material change to the risk and reward profile of the product having a direct impact on any of the following sections of the KID:
a. What is this product? (e.g. if the mechanics or terms of the products change, for instance a change in observation dates which would trigger a notice to the holders to be sent, or upon a restructuring ).
b. What are the costs? (e.g. when the costs impacting performance of the product change)
c. How long can I hold it and can I take my money out? (e.g. change in the liquidity terms)
(ii) Under the same conditions as defined by CESR in its guidelines on the methodology for the calculation of a SRRI (CESR/10-673), i.e. the KID should be updated when the risk indicator differs from the displayed risk indicator for 4 consecutive months on each of the computation dates. The risk indicator should be computed every week.
For reference, CESR’s guidelines on the methodology for the calculation of a SRRI (CESR/10-673) set the following conditions to updating the KID because of a change in the risk indicator:
“The synthetic risk and reward indicator shall be revised if the relevant volatility of the UCITS has fallen outside the bucket corresponding to its previous risk category on each weekly or monthly data reference point over the preceding 4 months.
3. Subject to the paragraph above, if the volatility of the UCITS has moved so as to correspond to more than one bucket during the 4-month period, the UCITS shall be attributed the new risk class corresponding to the bucket which its relevant volatility has matched for the majority of the weekly or monthly data reference point during the preceding 4 months.”
The focus of the question on products “being sold or traded on secondary market” is the right one, as these products should not be confused with the ones listed on an exchange but with no actual trading or sales, among which many are non-continuously available products.
The challenges that can be foreseen for these products is the one mentioned in our answer to Q49: their sheer volume would make it impractical to have to update their KIDs annually. It is important therefore to define precisely and not extensively the criteria that will trigger an update, considering in particular the fact that the valuation of these products already includes any change in their risk and reward profile.
AMAFI is not sure what a PRIIP offering a wide range of investment options is referring to (insurance based PRIIPS?) and is therefore unable to answer this question.
As explained in its answer to Q49, AMAFI is not in favour of an active communication model. It could be argued that this would be relevant in the context of investment advice but this would significantly change the extent of this investment service and would be at odds with the policy choices made so far in this respect (MIFID/MIFIR).
In any case, if the choice of an active communication model was made, there are two important conditions that should be satisfied:
- The update of the KID should not be based on extensive criteria to ensure feasibility considering the number of products in scope;
- The entity in direct relation with the investor should be the one responsible for ensuring this communication.
Yes, AMAFI agrees.
Given the wide range of products in scope (structured deposits, life insurances policies, warrants and certificates, CFDs, structured products, OTC derivatives, convertibles…), manufacturers will have no other choice than automating the production of KIDs, when possible, for cost reasons, feasibility and consistency. Major manufacturers of products will indeed have several thousands of new products in scope every year – automation of KIDs will be necessary to accommodate this volume, or at least a portion of it. Indeed, the production of KIDs cannot be fully industrialized since some of the products in scope are customised by nature (such as OTC products) and do not lend themselves to automation. It is more likely that automation of the production of the KIDs will only be possible for products distributed in a public offering context.
However, even though automation will not be possible for all types of products, templates of KIDs for the different types of products concerned, will still be very useful. Considering the wide range of products in scope, a single KID template would indeed be inadequate. Instead, a KID template should be developed for each category of PRIIPS.
In AMAFI’s view, it is essential that such templates be developed at European level. This would facilitate comparison between products by investors, would provide more legal certainty, would make implementation easier for manufacturers and would also help categorizing the products in scope. Such approach would be consistent with the one adopted for the implementation of the UCITS IV Directive, whereby several templates of Key investor Information document were established after discussions with professionals.
This should be part of the level 2 measures for the reasons explained in Q34.
This question seems to be relevant for insurance type PRIIPS. Hence, AMAFI has no comment.
The choices that will be made as to the use of narratives or graphical illustrations for the performance scenarios will have different cost implications for manufacturers, the latter being more costly to produce.
Similarly, the criteria for reviewing and updating a KID will have significant impact on costs, as they will result in a higher or lower proportion of KIDs to be reviewed and updated.
The methodology for the calculation of a risk indicator may also have cost implications if it involves getting access to data not already available to manufacturers or developing models not already used by them.
KID automation will not be entirely possible and any case, any automation will produce KIDs that will need to be reviewed with great care by staff with the right expertise before they can be used. Hence, the assessment of costs should also include the manpower costs of producing KIDs.
AMAFI - Association française des marchés financiers