EUROPE: ESMA Issues Technical Discussion Paper Concerning KID’s for PRIIPs

Tuesday June 30 2015

The European Securities and Markets Authority (ESMA) issued a Technical Discussion Paper on 23 June 2015 concerning risk, performance scenarios and cost disclosures in key information documents for packaged retail and insurance-based investment products (PRIIPs).

The aim of this Technical Discussion Paper is to collect views on the possible methodologies to determine and display risks, performance and costs in the Key Information Document (KID) for PRIIPs. The paper is split into a section on risk and reward and a section on costs.

Risk and reward:

Three risks are considered for the risk indicator: market, credit and liquidity risk. This Paper presents four approaches that are being considered as viable risk indicators. The first approach is a qualitatively based indicator which combines credit and market risk, complemented by a quantitative market risk measure. The second approach is an indicator which separates market risk and credit risk. The third approach is an indicator based on quantitative market and credit risk measures and is calculated by using forward looking simulation models. The fourth and final approach is a two-level indicator where the first level roughly separates products based on their qualitative characteristics and the second level specifies the risk based on a quantitative assessment.

Another four approaches are highlighted for performance scenarios. The first approach is to let the manufacturer of a PRIIP decide which scenarios to present in the KID (the so called what-if: manufacturer choice). A second approach is to prescribe which scenarios should be included in the KID. The third approach is one that takes probabilities of outcomes into account in the scenario selection. The fourth approach is described is a combination of the previous approaches.

Costs:

This section starts with the aim of identifying the different types of costs of the different types of PRIIPs, and identifying the specific issues related to the calculation of some of these costs (e.g. transaction costs and performance fees, notably in the case of funds, or cost related to biometric risk premium in the case of life-insurance products).

The second part of the costs section aims to assess the different possible ways of aggregating the different types of costs, including the different possible definitions of the overall cost ratio (summary cost indicator), and the possible ways of calculating the cumulative effect of costs.

The list of costs identified in the case of funds is inspired by the UCITS example, but it includes different types of costs that were excluded from the ‘ongoing changes figure’ of UCITS (e.g. transaction costs). This list is detailed and benefits from the experience of the CESR guidelines on the methodology for calculation of the ongoing charges figure in the Key Investor Information Document.

The list of costs identified in the case of life-insurance products makes it clear that, as opposed to investment funds, the definition of the different types of costs of this type of PRIIPs is not harmonised within the EU. This list distinguishes between the case of unit-linked products and with-profit contracts. It also highlights that there are some specific issues relating to the costs of life-insurance products, including the way of handling the (costs of) biometric risk premium of these products, the allocation of costs in the case of with-profits contracts, and the costs related to embedded guarantees and options.

The list of costs identified in the case of structured products emphasises the fact that the main part of these costs is included in the price of the product and that the estimate of the fair value of the product is therefore needed to calculate its costs. The different types of costs of SPVs are also discussed in this part.

Two main possible approaches for aggregating the costs of different types of PRIIPs are presented: Reduction in Yield (RIY) and Total Cost Ratio (TCR).

Specific issues related to the TCR in the case of different types of PRIIPs are discussed (e.g. the most appropriate definition of the denominator of this ratio) and the extent to which the principles that govern the use of the ongoing charges figure of UCITS could apply to the TCR if applied to the different types of PRIIPs.

Specific issues related to the RIY and TCR in the case of different types of PRIIPs are discussed (e.g. the yield assumption(s) to be taken and the way it handles the biometric benefits).

With respect to the cumulative effects of costs, the assumptions on growth rates and the interaction with the reward section of the KID are discussed.

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