PRIIPs (packaged retail and insurance-based investment products) include the range of investment products marketed to retail investors which are subject to investment risk. These can be options, derivatives, funds, or other products.
The EU first passed European PRIIPs Regulations in 2017. They were then transposed into UK law and ‘onshored’ post-Brexit. PRIIPs regulation was the first to deal with pre-contractual information by requiring key information documents (KIDs). KIDs provide consumer-friendly information about the key features of an investment product, including potential gains and the risks involved in investment. They must be provided by those who produce, advise on, or sell PRIIPs to consumers.
The original aims of PRIIPs regulation were to improve protection for retail investors in the financial market and regain consumer confidence after the financial crash. KIDs enable investors to compare PRIIPs across the EU and the UK, whether they’re offered by banking, insurance, or securities firms.
But the FCA has had concerns about the PRIIPs framework for years—before Brexit, they made concerted efforts to amend the EU rules. For some products, KIDs can contain misleading information thanks to the methodologies used to create performance scenarios. There has also been a distinct lack of clarity within the PRIIPs rules over the corporate bond market. So, post-Brexit, the UK is diverging from EU PRIIPs regulation to better protect consumers.
The new PRIIPs disclosure rules, as amended by the FCA, are effective January 1, 2022. The updated regulations will provide more clarity to consumers about what investment products are, the risk involved, and likely future performance.
Firms will have more flexibility to ensure that their communications are understandable and help consumers make well-informed investment decisions. Here are the three key ways PRIIPs will diverge from the EU framework, and what you need to know to prepare.
The scope of EU PRIIPs regulation was potentially ambiguous, leaving room for doubt around certain terms and features of debt securities that would exclude them from being considered a PRIIP. Corporate bonds are the hot-button issue in this category, and the FCA is introducing rules to prevent corporate bonds with certain common features from being classified as PRIIPs.
Debt securities will not be considered PRIIPs if:
- The overall return for the investor is determined by the economic performance of the commercial or industrial activities of the issuer
- They include a fixed coupon, even if the coupon is subject to pre-defined changes
- They include a put or call option, as long as the option is not exercisable in response to fluctuations in reference values or the performance or investment assets
- They have a perpetual or indefinite term, or if they are subordinate in the creditor hierarchy in the event of the issuer’s insolvency, without meeting other PRIIP criteria
The new regulations will also clarify what it means for a PRIIP to be ‘made available’ to retail investors.
Amending performance scenarios
PRIIPs rules require providers to include ‘performance scenarios’ in their KIDs. These scenarios are calculated using specific methodologies provided in the PRIIPs regulations, including the use of historical data to calculate potential returns an investor can expect under different market conditions.
But firms have long had reservations over misleading illustrations across nearly all asset classes, including overly optimistic estimates of an investment’s potential returns.
Per the FCA’s new rules, ‘performance scenarios’ will become ‘information on performance,’ allowing KIDs the ability to include factors likely to affect performance in ‘narrative form.’ This would include factors that could have a material impact on the funds’ performance.
The narrative would include an overview of three scenarios for investment performance: favourable, negative, or worst-case. It would also require disclosure of the relevant index, benchmark, target, or proxy, and an explanation of how the investment product will likely compare.
The PRIIP manufacturer must ensure the narrative is ‘accurate, fair, clear, non-misleading and likely to be understood,’ as well as ‘likely to be useful to retail investors in assessing the prospects for future returns.’
Along the same theme, the FCA will require an increase of the summary risk indicator (SRI) risk rating score where it is misleadingly low—especially where the PRIIP’s reference asset is illiquid. If the PRIIP manufacturer believes a score is too low, they must notify the FCA of the amended score and provide a brief explanation of the risk factors not adequately reflected in the SRI score.
Extending the UCITS exemption
In June 2021, the UK Treasury extended the UCITS funds’ exemption from PRIIPs regulation for five years, to December 31, 2026. Until that time, UCITS funds sold in the UK will not be required to produce the PRIIPs KID. The Treasury said this decision was made ‘to provide certainty for industry and investors regarding the disclosures UCITS funds providers will have to make to retail investors beyond the end of 2021.’
This decision is another divergence from the EU rules, which set the expiration date for the UCITS exemption at the end of June 2022. Changes to the UK regulation could come sooner than 2026, depending on the result of inquiries conducted before the extended expiry date. But for the time being, UCITS remain exempt under UK law.
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