When is a PRIIPs RTS not a PRIIPs RTS?

The objective of the PRIIPs KID has always been laudable – give retail investors a standardised pre-sale disclosure document that is clear, understandable and not misleading and that helps them compare products that aim to help them achieve similar goals but which are structured differently.

But the devil, as the saying goes, is in the detail.

The trouble started with the first iteration of the Regulatory Technical Standards (RTS) in 2016, which the European Parliament rejected, leading to a revised RTS being published in April 2017, less than eight months before the (delayed) KIDs live date.

Then the shouting really began.

As soon as the first KIDs were published, the future performance scenarios were criticised, as they took as their starting point the historical performance of the PRIIP, through a long bull market, with the bizarre consequence that some equity-based products showed positive returns in the unfavourable scenario.

The transaction cost calculations were also criticised, as the use of the “slippage cost” methodology led to some PRIIPs showing negative transaction costs, ie they appeared to make their investors a profit just by trading in the underlying instruments, which is clearly nonsense.

So the regulators started patching up the good ship PRIIPs KID before it sank beneath the waves. But a patched-up ship will never be as seaworthy as a newly-built one.

So when the combined European Supervisory Authorities (ESAs) consulted at the end of 2019 on the calculation and presentation of performance and costs, and on preparing the KID for when UCITS funds would be brought into line at the end of 2021, it was almost inevitable that the outcome wouldn’t be pretty.

A new RTS was published in July, but even before getting down to the details, there was a problem. Alongside the RTS was a letter to the Director General of Financial Stability, Services and Capital Markets Union (FISMA), saying that the Boards of only two of the three regulators managed to get a majority to support them.

The primary reason given was: “Those Board members that did not support the RTS, generally argued that a partial revision of the PRIIPs Delegated Regulation is not appropriate at this stage, prior to a comprehensive review”.

The letter went on: “A number of Board members also indicated that for investment funds, they would prefer the past performance graph from the UCITS key investor information document to be included in the PRIIPs KID”.

So we now have a revised RTS with several tweaks, such as:

Only two time periods for performance scenarios, with a third added if the recommended holding period (RHP) is 10 years or longer;
Continued use of the slippage cost methodology, but negative transaction costs are not permitted;
Continued use of historical performance to derive the future scenarios, but based on the greater of 10 years or (RHP + 5) years, using the PRIIP and/or a benchmark or proxy, on the basis that this will pick up a full market cycle.

Perhaps the strangest, and yet most expedient, change is the introduction of past performance for funds.

Because there are known to be MEPs with a strong and vocal objection to introducing this, the suggestion is to refer investors to a separate document on which a past performance graph similar to that currently on a UCITS KIID will be shown.

Not only could it be argued that this keeps past performance off the PRIIPs KID, but it gets around the need to revisit the Level 1 Regulation to extend the KID to a fourth page. The chairmen of the ESAs say that they agree with their members whose preference is for past performance to be included on the KID, but that is clearly a battle they know they are unlikely to win, at least in time to bring UCITS funds on board.

The ESAs’ letter to FISMA ends with this bombshell: “Given that the draft RTS was not adopted by the three ESA Boards, the ESAs are not in a position to formally submit an RTS to the Commission”, so this RTS is going nowhere right now.