Response to joint Discussion Paper on Key Information Documents (KIDs)
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We disagree that liquidity is a comparable risk to market risk or credit risk. Liquidity risk will only affect an investor’s return in certain circumstances (i.e. if they wish to exit a product before is redemption date), and many products, including structured products, are bought by investors with the intention of holding them for their full investment term.
We disagree with the definition of liquidity risk as the absence of a secondary market. Many PRIIPs are buy to hold investments, and may be based on underlying assets that are illiquid. The existing of an ‘active market’ cannot therefore guarantee liquidity. Defining liquidity should also include reference to the liquidity of any underlying assets and/or 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).
We suggest that liquidity risk should be described through narrative form in the KID, in line with the current practise for UCITS, and recognise that this narrative needs to be product-dependent (i.e. different descriptions of the risk may be needed for different types of PRIIP).
UCITS funds currently adopt a similar methodology (as defined by ESMA) and we believe adoption of a similar method will ensure PRIIPs and UCITs are on an equal playing field and that retail investors can compare the different investments available to them with similar risk indicators, avoiding any fundamental changes to the current UCITS Risk Rating (and the associated concerns that could cause).
Credit Risk: the UK Structured Products Association’s own Credit Risk Rating is based on the credit ratings assigned by the main independent ratings agencies.
We suggest that if probability-based testing is to be included in the KID, a methodology is defined to ensure consistency (i.e., based on past performance or forward looking and any assumptions used).
Scenario-based testing is an alternative used in the structured products industry in the UK. However, the scenarios selected can differ by product-type to ensure they are relevant to that particular payout. We suggest that if a scenario-based approach is adopted, a basic set of scenarios are prescribed (i.e., a gain, flat, or a loss) where manufacturers can then have the flexibility to add additional scenarios should it be seen as beneficial in aiding the explanation of how a product works.
This would require for example manufacturers to agree on the same risk premium to be included as one of the inputs into the model.
We consider that it may be challenging to list the assumptions and explain the modelling methodology in the KIID (both due to the premium on space in a 3-page document and also to ensure the explanation could be clearly understood by investors).
The treatment and disclosure of implicit costs needs to be agreed (i.e. they should not be deducted from estimated returns because these costs have already been deducted, as opposed to other costs). If it is necessary for these implicit costs to be disclosed, it is important that investors can understand that these costs will not impact the returns that they can achieve.
Given the limitation on space in the KID and the danger of providing too much information that the investor may not understand, it may be prudent to disclose a total cost figure, making sure that it is clear that this includes all costs as prescribed by the ESAs.
The description of implicit costs will also be a challenge, to ensure investors understand which costs will be deducted from any returns they receive and which are already taken into account.
One further challenge is in the presentation of costs for PRIIPs with a fixed investment term. Presenting cost information for a time period that differs from the tenor of the PRIIP may be misleading for investors.
The approach that the UK Structured Products Association has adopted in the UK is to display an alphanumerical risk rating for each structured product, with a numerical value from 1 to 7 to denote the market risk of a product, and a character from A to G to denote the credit risk of a product. Our view is that liquidity risk should be described as narrative rather than integrated into any risk rating, as per our response to question 3.
We suggest that information included on costs is limited to key information presented in a simple way to ensure that it can be understood easily by investors. Investors are likely to be primarily concerned about total costs, and displaying a breakdown of the costs may provide little value.
Further consideration is needed in the identification of relevant parties, including a clear definition of who the PRIIPs Manufacturer is. For retail structured products in the UK the issuer of the securities can differ from a Plan Manager for example. For third-party distributed products, roles need to be clearly defined to avoid any confusion over counterparty risk.
We question the need for a comprehension alert when it has been recommended that an investor seek independent financial advice. Retail investors should not be discouraged from investing in innovative products so long as they understand and accept the risks associated with such an investment.
Our understanding is that the KID is to make all products comparable and therefore if such an alert is used, it should be used across all products. We would welcome further guidance on exactly which products would and would not currently require this comprehension alert and the logic behind any such decisions.
If further disclosures are needed, we emphasise the important of consistency with MiFID II.
We also believe that further guidance is needed relating to any reissue of a KID. If there is a material change we believe the manufacturer should update the KID on their website, and that the entity that has provided any advice should assume responsibility of distributing the amended KID to investors where appropriate.
We do not believe that reverse enquiries should trigger an obligation to update a KID. The costs involved may deter the manufacturer and investors from facilitating/requesting such a service.
For PRIIPs covered by the Prospectus Directive, the existing requirements of the Prospectus Directive and the Transparency Directive already allow for sufficient protection for investors for the purpose of making them aware of updated information and significant changes.
2: Do you agree with the description of the consumer´s perspective on risk expressed in the Key Questions?
In general, we agree with the description in the Key Questions.3: Do your agree that market, credit and liquidity risk are the main risks for PRIIPs? Do you agree with the definitions the ESA’s propose for these?
We agree that market risk and credit risk are both key risks for PRIIPS and agree with ESA’s proposed definitions.We disagree that liquidity is a comparable risk to market risk or credit risk. Liquidity risk will only affect an investor’s return in certain circumstances (i.e. if they wish to exit a product before is redemption date), and many products, including structured products, are bought by investors with the intention of holding them for their full investment term.
We disagree with the definition of liquidity risk as the absence of a secondary market. Many PRIIPs are buy to hold investments, and may be based on underlying assets that are illiquid. The existing of an ‘active market’ cannot therefore guarantee liquidity. Defining liquidity should also include reference to the liquidity of any underlying assets and/or 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).
We suggest that liquidity risk should be described through narrative form in the KID, in line with the current practise for UCITS, and recognise that this narrative needs to be product-dependent (i.e. different descriptions of the risk may be needed for different types of PRIIP).
4: Do you have a view on the most appropriate measure(s) or combinations of these to be used to evaluate each type of risk? Do you consider some risk measures not appropriate in the PRIIPs context? Why? Please take into account access to data.
Market Risk: the UK Structured Products Association’s own Market Risk Rating is a volatility-based measure of the risk of a product, adapted to be fit for purpose for structured products. This uses actual historically observed data, rather than relying on predictions or assumptions.UCITS funds currently adopt a similar methodology (as defined by ESMA) and we believe adoption of a similar method will ensure PRIIPs and UCITs are on an equal playing field and that retail investors can compare the different investments available to them with similar risk indicators, avoiding any fundamental changes to the current UCITS Risk Rating (and the associated concerns that could cause).
Credit Risk: the UK Structured Products Association’s own Credit Risk Rating is based on the credit ratings assigned by the main independent ratings agencies.
5: How do you think market, credit and liquidity risk could be integrated? If you believe they cannot be integrated, what should be shown on each in the KID?
We do not understand what is meant by contingent costs.6: Do you think that performance scenarios should include or be based on probabilistic modelling, or instead show possible outcomes relevant for the payouts feasible under the PRIIP but without any implications as to their likelihood?
For structured products, risk to performance or loss of capital can easily be explained based on probability-based testing. But whilst this works well for structured products, it may be more challenging for other types of PRIIP. Standardisation may therefore be an issue as a methodology for probability-based testing needs to be agreed that suits a wide a range of PRIIPs as possible.We suggest that if probability-based testing is to be included in the KID, a methodology is defined to ensure consistency (i.e., based on past performance or forward looking and any assumptions used).
Scenario-based testing is an alternative used in the structured products industry in the UK. However, the scenarios selected can differ by product-type to ensure they are relevant to that particular payout. We suggest that if a scenario-based approach is adopted, a basic set of scenarios are prescribed (i.e., a gain, flat, or a loss) where manufacturers can then have the flexibility to add additional scenarios should it be seen as beneficial in aiding the explanation of how a product works.
7: How would you ensure a consistent approach across both firms and products were a modelling approach to be adopted?
Given the need for consistency, we suggest that all modelling be carried out according to a common set of rules and assumptions as set out by the ESAs, however we believe it is unrealistic to expect that all manufacturers could agree on the same model for a given type of PRIIPS.This would require for example manufacturers to agree on the same risk premium to be included as one of the inputs into the model.
We consider that it may be challenging to list the assumptions and explain the modelling methodology in the KIID (both due to the premium on space in a 3-page document and also to ensure the explanation could be clearly understood by investors).
8: What time frames do you think would be appropriate for the performance scenarios?
We suggest that scenarios are based on the tenor of a PRIIP (with some standard guidelines set for open-ended products). It may be appropriate to introduce annualised rates for comparability, however caution should be taken when annualising rates for very short-dated products.9: Do you think that performance scenarios should include absolute figures, monetary amounts or percentages or a combination of these?
We suggest that performance scenarios are based on monetary amounts to the extent that some retail investors may not be fully comfortable with percentages. However, it may be prudent to establish some standardisation of the level of investment that it is based on (e.g., £10,000 or €10,000).10: Are you aware of any practical issues that might arise with performance scenarios presented net of costs?
We strongly believe that it needs to be consistent with how funds describe their costs (i.e., currently just inclusive of any annual management charges).11: Do you have any preferences in terms of the number or range of scenarios presented? Please explain.
We suggest that five generic scenarios could be suitable for most PRIIPs: strongly negative, negative, neutral, above average, positive. It could be considered to give manufacturers the flexibility to add more if required.12: Do you have any views, positive or negative, on the different examples for presentation of a summary risk indicator? Please outline advantages and disadvantages, and provide any other examples that you are aware of that you think would be useful.
Please refer to our response for question 5 (i.e., a alphanumeric indicator with components for market risk and credit risk).14: Do you have any views on possible combinations of a summary risk indicator with performance scenarios?
We suggest that a summary risk indicator is kept separate from performance scenarios as these two elements serve different purposes and would not be intuitive for investors to understand.15: Do you agree with the description of the consumer´s perspective on costs expressed in the Key Questions?
In general, we agree with questions 1, 4, 5, 7 and 8. However, when describing costs it needs to be made clear that these are the costs that are known to the manufacturer.16: What are the main challenges you see in achieving a level-playing field in cost disclosures, and how would you address them?
We question what value the disclosure of fair value would bring to investors, as the fair value of a PRIIP will include factors specific to the manufacturer (e.g. efficiency of trading platform or funding levels) that have no impact on investors. Instead, more pertinent information for investors would be the a) potential return on offer and b) the risks inherent in the product.17: Do you agree with the outline of the main features of the cost structures for insurance-based investment products, structured products, CfDs and derivatives? Please describe any other costs or charges that should be included.
For products where the offer period has closed and that are only available on the secondary market, it may be disproportionate to update the KID in each instance.18: Do you have any views on how implicit costs, for instance costs embedded within the price of a structured product, might be best estimated or calculated?
Ensuring that cost disclosures are comparable and consistent across different PRIIPs is a key challenge. It will be important to ensure that all manufacturers disclose the same types of costs using the same methodology, as prescribed by the ESAs.The treatment and disclosure of implicit costs needs to be agreed (i.e. they should not be deducted from estimated returns because these costs have already been deducted, as opposed to other costs). If it is necessary for these implicit costs to be disclosed, it is important that investors can understand that these costs will not impact the returns that they can achieve.
Given the limitation on space in the KID and the danger of providing too much information that the investor may not understand, it may be prudent to disclose a total cost figure, making sure that it is clear that this includes all costs as prescribed by the ESAs.
19: Do you agree with the costs and charges to be disclosed to investors as listed in table 12? If not please state your reasons, including describing any other cost or charges that should be included and the method of calculation.
We believe that it is not beneficial to the investor to disclose implicit costs. These costs are already embedded in the terms shown to investors and are only an estimation before the strike date of the product. To the extent that it is agreed that implicit costs must be disclosed, it must be made clear to investors that these costs will not detract from any returns that they may receive from investing in the PRIIP.20: Do you agree that a RIY or similar calculation method might be used for preparing ‘total aggregate cost’ figures?
We believe that a RIY may be difficult for retail investors to understand.21: Are you aware of any other calculation methodologies for costs that should be considered by the ESAs?
We suggest that the Total Expense Ratio (TER) could be an alternative calculation methodology, but this needs to be consistent and standardised with the fund industry (i.e. it must include considerations of the same costs).22: Do you agree that implicit or explicit growth rates should be assumed for the purpose of estimating ‘total aggregate costs’? How might these be set, and should these assumptions be adjusted so as to be consistent with information included on the performance scenarios?
This is not relevant for structured products.23: How do you think implicit portfolio transaction costs should be taken into account, bearing in mind also possible methods for assessing implicit costs for structured products?
Implicit portfolio transaction costs are already taken into account for structured products in the terms shown to investors.24: Do you have any views on possible assumptions that should be made, and how these might be calibrated or set?
Given the range of products captured by the PRIIPs regulations, a key challenge will be to ensure costs are disclosed in a standard format without being confusing for investors.The description of implicit costs will also be a challenge, to ensure investors understand which costs will be deducted from any returns they receive and which are already taken into account.
One further challenge is in the presentation of costs for PRIIPs with a fixed investment term. Presenting cost information for a time period that differs from the tenor of the PRIIP may be misleading for investors.
25: What do you think are the key challenges in standardising the format of cost information across different PRIIPs, e.g. funds, derivatives, life insurance contracts?
Our preference is for a simple representation to display costs, in a way that makes it easy for investors to understand the distinction between upfront, ongoing, performance-related and exist costs. We prefer this information in a table format. Option 5 is the closest to our preference.26: Do you have a marked preference or any objection for any of the presentational examples? If so, why? Please provide any alternative examples which you believe could be useful.
No, we believe this would work for structured products. If costs are not applicable, the field could be left blank.27: In terms of a possible breakdown of costs, are you aware of cost structures for which a split between entry or exit costs, ongoing costs, and costs only paid in specific situations or under specific conditions, would not work?
Our view is that these three risks cannot be integrated into one single rating as they are fundamentally very different risks. These different risks may also vary significantly in importance for each investor, and aggregating the risks may prevent them from isolating the risks that are most important to them.The approach that the UK Structured Products Association has adopted in the UK is to display an alphanumerical risk rating for each structured product, with a numerical value from 1 to 7 to denote the market risk of a product, and a character from A to G to denote the credit risk of a product. Our view is that liquidity risk should be described as narrative rather than integrated into any risk rating, as per our response to question 3.
28: How do you think contingent costs should be addressed when showing total aggregated costs?
As a percentage of the amount invested, preferably in table format.29: How do you think should cumulative costs be shown?
The costs included in table 12 should be wide enough to capture all costs relevant to products covered by PRIIPs. However, only the relevant costs should be disclosed for specific PRIIPs.We suggest that information included on costs is limited to key information presented in a simple way to ensure that it can be understood easily by investors. Investors are likely to be primarily concerned about total costs, and displaying a breakdown of the costs may provide little value.
30: Do you have any views on the identity information that should be included?
ISINs should be used where possible.Further consideration is needed in the identification of relevant parties, including a clear definition of who the PRIIPs Manufacturer is. For retail structured products in the UK the issuer of the securities can differ from a Plan Manager for example. For third-party distributed products, roles need to be clearly defined to avoid any confusion over counterparty risk.
31: Do you consider that the criteria set out in recital 18 are sufficiently clear, or would you see some merit in ESAs clarifying them further?
We strongly disagree with the view that using a number of different mechanisms increases systematically the risk of misunderstanding on the part of the retail investor.We question the need for a comprehension alert when it has been recommended that an investor seek independent financial advice. Retail investors should not be discouraged from investing in innovative products so long as they understand and accept the risks associated with such an investment.
Our understanding is that the KID is to make all products comparable and therefore if such an alert is used, it should be used across all products. We would welcome further guidance on exactly which products would and would not currently require this comprehension alert and the logic behind any such decisions.
32: Do you agree that principles on how a PRIIP might be assigned a ‘type’ will be needed, and do you have views on how these might be set?
We agree in principle.36: Do you have views on the information PRIIPs manufacturers should provide on consumer types?
We believe we should be mindful of the space available on the KID and its purpose to provide summary information. Any section on identifying consumer types should be concise and should not duplicate information available elsewhere in the KID. Realistically, there may only be space to disclose the most important information relating to consumer type, namely ability to bear loss and investment horizon.If further disclosures are needed, we emphasise the important of consistency with MiFID II.
39: Are you aware of specific challenges arising for specific PRIIPs in completing this section?
We believe that further clarification is needed to provide a clear definition for Manufacturer, as per our response to question 30.40: Are you aware of specific challenges arising for specific PRIIPs in completing this section?
In respect of structured products, there is a challenge where there is the potential for a product to mature early as a result of an early maturity features (i.e. ‘kick outs’).41: Are you aware of specific challenges arising for specific PRIIPs in completing this section?
No. However it should be made clear that if a PRIIP has been sold via an adviser or intermediary, they should be the first point of call for complaints.42: Do you agree that this section should link to a webpage of the manufacturer?
Yes.43: Do you agree with the assessment of when PRIIPs might be concerned by article 6(3)?
Yes.49: Do you agree with the measures outlined for periodic review, revision and republication of the KID where ‘material’ changes are found?
Our view is that the KID is a pre-contractual document and once the offer period is closed, the republication of a KID has limited value for investors (in the absence of a material change to the terms of that product). We suggest that the KID should therefore only be updated to reflect changes that have the potential to significantly impact investment decisions relating to future redemptions of that product. This does not for example include changes to a Risk indicator.We also believe that further guidance is needed relating to any reissue of a KID. If there is a material change we believe the manufacturer should update the KID on their website, and that the entity that has provided any advice should assume responsibility of distributing the amended KID to investors where appropriate.
50: Where a PRIIP is being sold or traded on a secondary market, do you foresee particular challenges in keeping the KID up-to-date?
Where products are not actively traded on a secondary market (including the majority of structured products in the UK), requiring a manufacturer to review and update a KID on a continuous basis may be disproportionate and provide little investor benefit.We do not believe that reverse enquiries should trigger an obligation to update a KID. The costs involved may deter the manufacturer and investors from facilitating/requesting such a service.
For PRIIPs covered by the Prospectus Directive, the existing requirements of the Prospectus Directive and the Transparency Directive already allow for sufficient protection for investors for the purpose of making them aware of updated information and significant changes.