Response to joint Discussion Paper on Key Information Documents (KIDs)
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Regarding the question “What are the risks and what could I get in return”, it is important to clearly separate risks and expected performance, to avoid the risk that consumers pay more attention to the performance than to risk. However, it should be made clear that there is a trade-off between risk and reward.
There should also be coverage for certain product types of discrete events that may lead to gains or losses as the range of returns may be volatile or contain regular ongoing income or coupon payments. In addition commentary on any asymmetry (e.g. where there is leverage) in the return profile should be highlighted if the potential upside returns are structurally different to the downside returns.
As far as credit risk is concerned, the quantitative measure proposed will not be applicable to most of the issuers of insurance based products, which are not listed and have not had a credit rating issued by a rating agency. Lack of listing and/or credit rating does not of necessity mean greater risk than in the case of rated companies. Insurance companies, irrespective of listed status or credit rating, are subject to the same prudential rules and supervision.
Solvency II creates a level playing field in regulatory terms, requiring all providers to measure themselves to a 99.5% confidence level (and could as such be converted to a credit rating). It is not, though, a guarantee that a company will never fail and therefore credit risk should be highlighted and measured when possible, though various factors make its meaningful measurement difficult.
With regard to possible measures of liquidity risk, it is clear that quantitative measures like the bid-offer spread or the average volume traded are meaningless for insurance-based investment products, for which only qualitative measures explaining the consequences of cashing in early are possible. For Unit-Linked products in which the investor bears the investment risk attention should be paid to the liquidity of the underlying assets, which then could be measured by the quantitative measures referred above. In any case, for products which are explicitly designed and marketed for a longer time horizon (e.g. old-age provision products), the liquidity aspects should not be over-emphasized.
Nevertheless, the first option has the major disadvantage to suggest to the customer that the scenarios are equally probable or worse, that the middle or average scenario is the most likely. Representation of “high” and “low” scenarios with no “middle” scenario could address this disadvantage. The second option has the main disadvantage of relying on the choice of a model and of its assumptions. So, unless there is a single model approved by the authorities, we do not see how the results from different models could be compared by the customer.
One possible answer to this dilemma could be to use the distribution of past returns as a proxy for the distribution of expected returns and then assign the resulting probability to each scenario. Stochastic analysis could be used to determine a generic range of outcomes and benefits. This is particularly the case for more complex and/or structured products. The analysis could be based on a standard stochastic model and tables to be used for combinations of funds or more complex funds. The models should be relatively simple and be sufficient to demonstrate the uncertainty of returns.
Cost profit participation of the customer should be taken into account, such that the customer gets a realistic scenario.
Summary risk indicators may, however, fail to capture certain non-linear product return profiles (for example in the case of certain derivative or structured products) where small changes in a reference value could have a disproportionate effect on capital returned. In these cases a specific risk warning may be required and/or warning that the product is ‘complex’ as envisaged in the PRIIPS regulation.
The summary risk indicator should focus on the market risk component with counterparty risk and liquidity risk covered by way of narrative explanation of the nature of the risk (see 5 above).
For structured products, the fair value approach should not be omitted.
We believe an implicit growth rate of risk free real rate of return should be used. This would broadly equate to the historic “real” rate of return on cash based investments and represent a simple and consistent base line across all products. For products with non linear charges (e.g. performance fees) we believe that a second higher rate of return should be used in order to illustrate the level of charges allowing for performance fees.
2: Do you agree with the description of the consumer´s perspective on risk expressed in the Key Questions?
Yes, in general, but some wording should be modified: for example, one of the key questions is : How much can I win ? or How much I am likely to win? We consider that investing is not a game and that these types of products (the PRIIPs) are not gambling so instead of using the verb “win” we would prefer to use “earn” or “gain”.Regarding the question “What are the risks and what could I get in return”, it is important to clearly separate risks and expected performance, to avoid the risk that consumers pay more attention to the performance than to risk. However, it should be made clear that there is a trade-off between risk and reward.
There should also be coverage for certain product types of discrete events that may lead to gains or losses as the range of returns may be volatile or contain regular ongoing income or coupon payments. In addition commentary on any asymmetry (e.g. where there is leverage) in the return profile should be highlighted if the potential upside returns are structurally different to the downside returns.
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?
Yes we agree with this list but suggest that other risks be added, such as: operational risk, concentration risk and the “bad management” risk for products that are actively managed (and in some cases also for products that are passively managed).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.
As volatility takes into account equally upwards or downwards variations, it is not a measure coherent with the implicit definition of risks resulting from the Key questions above. Nevertheless as the intention of this regulation is to provide the customer with a document that will facilitate the comparison of all types of investment products including those which are not yet covered by this regulation, like UCITS, it may be preferable to keep the measure, based on historical volatility, that is already used in the KID for UCITS. Note also that the advantage of such a measure is that it does not depend on the model chosen and of the assumptions, contrary to the other ones proposed.As far as credit risk is concerned, the quantitative measure proposed will not be applicable to most of the issuers of insurance based products, which are not listed and have not had a credit rating issued by a rating agency. Lack of listing and/or credit rating does not of necessity mean greater risk than in the case of rated companies. Insurance companies, irrespective of listed status or credit rating, are subject to the same prudential rules and supervision.
Solvency II creates a level playing field in regulatory terms, requiring all providers to measure themselves to a 99.5% confidence level (and could as such be converted to a credit rating). It is not, though, a guarantee that a company will never fail and therefore credit risk should be highlighted and measured when possible, though various factors make its meaningful measurement difficult.
With regard to possible measures of liquidity risk, it is clear that quantitative measures like the bid-offer spread or the average volume traded are meaningless for insurance-based investment products, for which only qualitative measures explaining the consequences of cashing in early are possible. For Unit-Linked products in which the investor bears the investment risk attention should be paid to the liquidity of the underlying assets, which then could be measured by the quantitative measures referred above. In any case, for products which are explicitly designed and marketed for a longer time horizon (e.g. old-age provision products), the liquidity aspects should not be over-emphasized.
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?
N/A6: 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?
We agree with the description made in paragraph 3.6.1.Nevertheless, the first option has the major disadvantage to suggest to the customer that the scenarios are equally probable or worse, that the middle or average scenario is the most likely. Representation of “high” and “low” scenarios with no “middle” scenario could address this disadvantage. The second option has the main disadvantage of relying on the choice of a model and of its assumptions. So, unless there is a single model approved by the authorities, we do not see how the results from different models could be compared by the customer.
One possible answer to this dilemma could be to use the distribution of past returns as a proxy for the distribution of expected returns and then assign the resulting probability to each scenario. Stochastic analysis could be used to determine a generic range of outcomes and benefits. This is particularly the case for more complex and/or structured products. The analysis could be based on a standard stochastic model and tables to be used for combinations of funds or more complex funds. The models should be relatively simple and be sufficient to demonstrate the uncertainty of returns.
7: How would you ensure a consistent approach across both firms and products were a modelling approach to be adopted?
See above answer to question 68: What time frames do you think would be appropriate for the performance scenarios?
Each product must be proposed for a certain time horizon, which is coherent with the nature and the features of the product. Time frames of scenarios should be in line with this horizon. In case of possible early redemption, it is useful to deliver a warning to the customer that the performance could be very different from that calculated for the scenarios. To deal with the early redemption issue more fully, annual performance could be shown annually up to say 5 years and at intervals thereafter.9: Do you think that performance scenarios should include absolute figures, monetary amounts or percentages or a combination of these?
If absolute or monetary figures are given, they should refer to an investment common to all products, for instance 1000 euros or the equivalent for non-Euro countries. Graphical representation of performance scenarios would be useful to make them more readily understood.10: Are you aware of any practical issues that might arise with performance scenarios presented net of costs?
It is of utmost importance that the performance scenarios are consistent with the information on costs included in the cost section of the KID and that the performance scenarios be presented net of costs.Cost profit participation of the customer should be taken into account, such that the customer gets a realistic scenario.
11: Do you have any preferences in terms of the number or range of scenarios presented? Please explain.
Our preferred option would be 5 scenarios.( 2 upwards, one middel and two downwards scenarios) but as any graph with five lines or scenario representations will be quite crowded and potentially hard to understand, representation of only two scenaios, one “high” and one “low”, a 10th or 25th percentile and a 90th or 75th percentile could adress this disadvantage, to demonstrate the range of returns.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.
Except for the fact that one cannot use the same type of indicator as for refrigerator, (and that high risk is not to be rejected like high energy consumption) we have no objection to the different suggestions made, but we would prefer the use of multiple visual elements as described in page 39 and 40.Summary risk indicators may, however, fail to capture certain non-linear product return profiles (for example in the case of certain derivative or structured products) where small changes in a reference value could have a disproportionate effect on capital returned. In these cases a specific risk warning may be required and/or warning that the product is ‘complex’ as envisaged in the PRIIPS regulation.
The summary risk indicator should focus on the market risk component with counterparty risk and liquidity risk covered by way of narrative explanation of the nature of the risk (see 5 above).
13: Do you have any views, positive or negative, on the different examples for presentation of performance scenarios? Please outline advantages and disadvantages, and provide any other examples that you are aware of that you think would be useful.
The examples presented at page 43 seem clear and not misleading. They show the range of possible outcomes, the extent to which “best” and “worst” can diverge over time, and the ABI figure usefully combines monetary and graphical representations.14: Do you have any views on possible combinations of a summary risk indicator with performance scenarios?
No, because we do not consider that it is realistic to propose a summary risk indicator.15: Do you agree with the description of the consumer´s perspective on costs expressed in the Key Questions?
Yes16: What are the main challenges you see in achieving a level-playing field in cost disclosures, and how would you address them?
In general, we agree. For insurance based investment products, one question is whether the premium for additional insurance benefits (insurance protection against death, disability, etc.) should or should not be regarded as a cost.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.
N/A18: 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?
The main challenges comes from the fact that certain costs are not directly identifiable, but are hidden (spread etc.) or are very difficult to assess. For instance, cross subsidies between disclosable and non-disclosable costs can distort the picture. In addition, costs of direct as opposed to indirect investment should be treated consistently.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.
When you know how the product is structured, it is always possible to calculate costs in comparing the estimated value of the product based on market quotations of the different constituents and its price. Alternatively, these could be estimated by requiring the structured product provider to provide an immediate encashment or unwind value of the product on the assumption that it was encashed the day after it was sold to the client. The difference between the price paid by the client and the encashment value would allow for the costs embedded in the structured product. This would be based on an “arms length” cost and if possible demonstrated by actual transactions.20: Do you agree that a RIY or similar calculation method might be used for preparing ‘total aggregate cost’ figures?
Yes, but this has to be consistent with the presentation of performance scenarios which will be done net of costs. .For structured products, the fair value approach should not be omitted.
21: Are you aware of any other calculation methodologies for costs that should be considered by the ESAs?
N/A22: 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?
As mentioned before, it is essential that the information on costs included in the cost section of the KID is consistent with the performance scenarios. .We believe an implicit growth rate of risk free real rate of return should be used. This would broadly equate to the historic “real” rate of return on cash based investments and represent a simple and consistent base line across all products. For products with non linear charges (e.g. performance fees) we believe that a second higher rate of return should be used in order to illustrate the level of charges allowing for performance fees.