New PRIIPs RTS include stress scenarios and MiFID II complexity definitions

The EU Commission has published redrafted PRIIPs RTS on its website. The amended rules state that KIDs will now contain a fourth “stress scenario”.  Comprehension alerts are explicitly linked to the MiFID II definitions for complex and non-complex instruments. In drawing up the amended rules, the Commission worked with other EU institutions. This consultation raises the possibility that final RTS could be agreed during a shortened scrutiny period and may allow industry to hope that final implementation work can start in the near future. However, the formal legal procedure has to be respected, and these new RTS could still be rejected by the European Parliament.

Key changes

  • Key information documents (KIDs) will now include a fourth stress scenario
  • Calculation methods have not changed and past performance of the product will not be stated in the KID
  • Comprehension alerts will be linked to MiFID II complexity definitions
  • Clarification on the treatment of multi-option PRIIPS including the use of UCITS KIID and synthetic risk and reward measures in certain circumstances

What has changed in the redrafted rules?

The redrafted rules have been eagerly awaited by the financial industry.  The Commission’s announcement relates to two of the most contentious issues, namely calculation methodologies for performance scenarios and the consistent use of comprehension alerts.  

1.     Performance scenarios

While including performance scenarios in the PRIIP-KID has been the subject of much debate, a fourth performance scenario has been added to address the European Parliament’s concerns about performance scenario calculations. This fourth scenario is the so-called "stress scenario", which sets out significant unfavourable impacts of the product not already covered in the unfavourable scenario. The stress scenario shows what a customer may get back in extreme market circumstances (but without “what happens if the manufacturer is unable to pay out”).

For industry, this new method will require some implementation effort, for example with regard to measuring volatility based on a certain formula. However, the addition of a stress scenario comes in response to industry concerns that existing scenarios could indicate a positive result even where the investor was at risk of losing capital, and were therefore misleading. Introducing a mandatory stress scenario addresses this issue by making the investor more aware of the risks of capital loss.

The amended guidelines also retain the existing calculation methodologies. This is despite some calls by the fund industry for a UCITS-type approach, where a historical outlook is offered without being used to predict future performance. In the new PRIIPs RTS, future performance scenarios will continue to be calibrated based on past data, although past performance of the product is not itself stated in the KID. Many will interpret this as a clear signal of the regulator’s commitment to the calculation methodology as it stands. In the absence of any move towards aligning the PRIIPs model with their existing one, this news may prompt generators familiar with UCITS to reconsider their calculation processes.

2.     Comprehension alerts to align with MiFID II

Meanwhile, the consistent use of comprehension alerts has become an increasingly important question as MiFID II and PRIIPs timetables have become aligned. This announcement establishes a common definition of instrument complexity, underlining the extent to which the two regulations overlap and should be considered in a common approach by financial institutions.

3.     Further clarification still needed on updating frequency

Some topics are also conspicuous by their absence. The latest guidance does not amend the review and revision articles and, hence, it is still not fully clear when a KID needs to be updated and how such updates must be communicated (although recital 20 remains useful). Updating frequency is a critical topic as firms work to put processes and data in place for investor protection compliance under both regulations.  In particular, firms will need to consider how to align data flows for PRIIPs-KIDs and MiFID II pre-trade transparency checks with updating frequency requirements. Clarification on this topic will therefore be needed in the Level 3 guidance.

Background

Disagreement on four areas of the original Level 2 legal guidance led to its rejection by the European Parliament in September 2016. The Commission has been working with the ESAs since November to agree on redrafted RTS, concentrating on the areas disputed by the European Parliament. These refer to the treatment of Multi Option Products (MOPs), changes to performance scenario calculations to make unfavorable scenarios less optimistic, the application of a comprehension alert and the disclosure of insurance costs and benefits, where applicable. The announcement starts a scrutiny period by the Parliament and Council before the revised PRIIPs RTS can be formally established.

Further reading

8 March 2017 draft RTS

8 March 2017 draft RTS Annex

SIX will continue to update you

SIX is closely following the developments regarding PRIIPs KID and will update you as soon as new information is available.

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