Mario Mantrisi, Senior Advisor to the CEO at KNEIP
Whilst financial services companies have been grappling with the consequences of Great Britainvoting to exit the European Union a key regulation and it’s fast approaching implementation date has gone largely unnoticed by many firms.
The Packaged Retail and Insurance-based Investment Products (PRIIPs) regulation will go live on December 31st, 2016. PRIIPs will impact all financial products sold to retail clients that are packaged, so that includes structured deposits, certain insurance products, and over-the-counter products such as options and warrants.
Regardless of the outcome of the Brexit negotiations, financial services regulation should not change in the next couple of years as a result of the vote. Funds and financial services institutions are required to respect existing agreements and implement new EU directives until Great Britain’s proposed exit is finalised. Great Britain was a major contributor to the EU directives, many of which are today transposed into UK law.
PRIIPs is the first Europe-wide regulation affecting pre-contractual information across the financial services sector (inc. banking, insurance and asset management). The objective is to promote the emergence of a single EU-wide insurance market, ensure the comparability between different products, improve transparency and restore retail investor trust in financial institutions and harmonize the framework of administrative and financial penalties on an EU-wide basis.
PRIIPs aims to achieve these objectives by clarifying and defining Key Information Documents (“KID”) and by making financial institutions share this information prior to any agreements or proposals.
Significant changes ahead
The PRIIPs regulation will introduce the much debated KID, which will eventually replace the familiar Key Investor Information Document (KIID), but this should not happen before 2019. Therefore UCITS funds already producing KIIDs will be exempt from producing the KID until then, however they will still be required to produce the data for reporting purposes.
A stipulation of KIDs is that it must be written in plain language and shared with retail investors before they purchase any packaged financial and insurance based products. These types of documents are not a new phenomenon to the UCITS fund industry. Investor disclosure documents, KIIDs, were previously introduced under UCITS IV, however the European Commission has granted a 5-year grandfathering period for the KIID before deciding on its future. The KIID and KID documents are similar, but they are by no means identical.
At the moment the KIID is only applicable to UCITS funds, so PRIIPS asks for similar documentation for all financial instruments. The KIID document is fairly simplified and only two pages long, which makes it difficult to describe complex investment products. The KID allows for an additional page of information (3 pages).However there remains a responsibility for financial services businesses not to leave out important information by over-simplifying their documents.
KID will also change the nature of how investment rewards are represented. Financial services institutes will be tasked with predicting potential future rewards and maximum losses on invested capital, which will be a key requirement in the KID. Furthermore the documenting will also include past performance scenarios for funds. This aspect has caused some concern for large asset management firms and other financial services businesses. Many firms have highlighted that there is a risk that this typeof crystal-balling of product performance might be misleading to retail investors.
As the KID will be applicable to a variety of financial instruments, the challenge for the regulators will be to find a common approach and summarises a products risk. The risk summary is also expected not to disadvantage any type of instrument.
Accurate and transparent KID will form an important part in rebuilding retail investors and the public’s trust towards the financial services industry. However it remains counter intuitive to simplify investor documents in order to help reduce investor risk.
What does this mean for financial services businesses?
Many financial services firms we have spoken to have just woken up to the ramifications of the PRIIPs regulation. However the reality remains that the implementation deadline is less six months away. Therefore firms’ compliance departments are rushing to produce the necessary documentations, KIDs, and the calculations to support this. This means that existing teams and reporting requirements are under enormous pressure for the next few months.
Many firms will struggle to hire compliance staff to execute projects in the remaining timeframe. Therefore technology and external consultants are in high demand. These solutions make sense as hiring permanent staff for a specific project is not only costly from a long term perspective, but it takes time to hire the ‘right’ people.
The rush to produce these documents highlights a fundamental industry problem where regulation tends to be looked at by a case-by-case basis. We recommend a more holistic and horizontal approach, which means looking at themes of data and how they affect each regulation.
Now is the time to assess what your firm needs to do ahead of PRIIPs and look at the existing capabilities and consider whether the in-house team is able to meet the 31st December 2016 deadline. Those firms that started preparing earlier this year are likely to be on the right track, however other firms might struggle with these regulatory requirements and lean towards external support. The funds and institutions that aren’t prepared for PRIIPs need not despair, but they need to act now in order to meet the fast approaching deadline.