background
Packaged Retail and Insurance-based Investment Products (“PRIIPS”) can be either (or both) (a) investments issued by special purpose vehicles where, regardless of the legal form, the amount repayable to retail investors is subject to fluctuation because of exposure to reference values or to the performance of one or more assets that are not directly purchased by the retail investor (known as a PRIP); and/or (b) an insurance product which offers a maturity or surrender value where that maturity or surrender value is wholly or partially exposed, directly, or indirectly, to market fluctuations (known as an IBIP)…
The Regulation (EU) No 1286/2014 of the European Parliament and of the Council (“EU PRIIPs Regulation”) came into force on 1 January 2018 with the aim of increasing transparency. It allows investors to compare investment products through the issue of a standard short form disclosure document, namely the PRIIPS “key information document” (“PRIIPS KID”). The PRIIPS KID is shared with investors prior to the conclusion of the transaction, making it easier for retail investors to understand and compare the different features, risks, rewards, and costs of different products, by requiring such factors to be disclosed in a standardised way. Like other EU legislation that is directly applicable within the EU, the EU PRIIPS Regulation became part of UK law at the end of the transition period under the EU Withdrawal Act 2018. Consequently, there are now two versions of the legislation operating in parallel: the original EU PRIIPS Regulation and the UK PRIIPS Regulation, as amended during the onshoring process.
Under the UK PRIIPS Regulation, Undertakings for the Collective Investment in Transferable Securities (“UCITS”) funds are currently exempted from the requirements of the UK PRIIPS Regulation. Therefore, instead of producing a PRIIPS KID, UCITS funds providers can continue to produce a Key Investor Information Document (“KIID”), as per the requirements of the UCITS Directive. This exemption was initially valid until 31 December 2021.
Her Majesty’s Treasury (“HMT”) has recently announced that the current exemption for UCITS funds from the requirements of the UK PRIIPS Regulation will be extended from 31 December 2021 to 31 December 2026. HMT’s action is based on the provision in the Financial Services Act 2011 which granted power to extend the current exemption for UCITS funds up to a further 5 years. HMT clarified that, while this exemption is currently extended by 5 years, changes to the UK PRIIPs Regulation could be made or a new Regulation may be introduced, earlier than 2026, as a result of HMT’s review of the UK disclosure regime. In such a scenario, HMT would implement measures to ensure that PRIIPs providers, including those distributing UCITS, are able to comply with the new requirements.
summary
Following the feedback received in the consultation CP21/23, on 25 March 2022, the FCA published a policy statement (PS22/2) setting out the final policy position of the UK PRIIPs Regulation. The following changes have been made:
- Rules clarifying the scope of the UK PRIIPs Regulation for corporate bonds, addressing whether certain products could be excluded from falling within the definition of PRIIPs.
- Amendments made to the PRIIPs Regulatory Technical Standards (“RTS”) replacing the requirements and methodologies for presentation of performance scenarios in the KID, and now requiring narrative information based on performance to be provided.
- Addressed the concerns about certain applications of the ‘slippage’ methodology when calculating transaction costs.
rules clarifying the scope of PRIIPS
The FCA has clarified whether certain products will fall under the definition of a PRIIP, as follows:
FX forwards: FX Forwards, and FX Swaps, are offered to retail investors, and fall under the definition of a PRIIP.
REITs: the manufacturer of REITs is responsible for determining whether the REIT is a PRIIP or not.
Listed Investment Companies: if a collective investment undertaking falls under the definition of an ‘alternative investment fund’ and is available to the retail market, it would be considered a PRIIP.
Exchange Traded Derivatives (ETDs): if ETDs are offered to retail investors, they will fall under the definition of a PRIIP.
US ETFs: third-country manufacturers or distributors would be required to prepare and produce a KID.
Sukuk: characteristics of a Sukuk vary, and it is the responsibility of the manufacturer to decide whether a Sukuk is a PRIIP or not.
Regulated Covered Bonds: the manufacturer of regulated covered bonds is responsible for determining whether the characteristic of the bond constitutes a PRIIP.
Sovereign Bonds: do not fall under the definition of a PRIIPs.
SPACs: if a SPAC is publicly listed, it is not considered to fall within the definition of the PRIIPs Regulation. The manufacturer is responsible for considering the features of a SPAC (i.e. if an unlisted entity constitutes a PRIIP).
Royalty Companies: generally do not fall within the scope of PRIIPs where assets held by retail investors are publicly listed corporate shares. However, the manufacturer is responsible for determining if the Royalty Company is offering a PRIIP or not.
performance and risk requirements included within the kid
The following amendments have been made to the performance and risk disclosures of the KID:
| Summary | Amendments | |
| Removal of performance scenarios | The method for calculation and presentation of performance scenarios within the KID produced misleading and unrealistic outcomes.
Manufacturers were previously subject to obligations that were not compatible with the duty to ensure that the information in the KID is accurate, fair, clear, and not misleading. |
The methodology has been improved to ensure that future illustrations of potential future performance are informative to investors and not misleading.
The FCA has removed the requirement for PRIIPS manufacturers to display performance scenarios in the KID and instead, have introduced a narrative form of disclosure, requiring the manufacturer to (a) describe the factors likely to affect future performance; (b) disclose the most relevant index, benchmark or target as applicable and; (c) explain a favourable, negative and worst case scenario for how the investment might perform. This results in greater flexibility when describing performance factors. |
| Upgrading the product’s ‘Summary Risk Indicator’ (‘SRI’) score | The PRIIPs regime required the KID to contain a standardised risk score of between 1 and 7, calculated in accordance with the underlying methodology.
This requirement has been unpopular with respondents and the FCA have expressed concerns that, in some cases, the SRI produced delivers lower risk ratings than expected and was not capturing all risks associated with some PRIIPS. The SRI aims to help consumers choose a PRIIP depending on their risk appetite. Under estimation of overall risk or over estimation of overall risk, undermines the key objective of the UK PRIIPS Regulation. |
The FCA have introduced rules requiring PRIIPs manufacturers to upgrade a product’s SRI score when the score resulting from the application of the RTS methodology is too low.
The FCA now recommends that six is the appropriate minimum SRI for Venture Capital Trusts (“VCTs”) and where firms consider this to be too low, firms should upgrade the SRI score, in turn providing more consumer protection. Furthermore, the FCA has increased the character word limit to 400 from 200 characters, giving PRIIPs manufacturers more room to explain important risks not included in the SRI. However, this is subject to the exception that PRIIPs manufacturers must be confident that any description given of risk is clear and uses appropriate language, suitable for retail clients. |
disclosure of transaction costs
The following amendments have been made to the disclosure of transaction costs:
| Summary | Amendments | |
| Treatment of anti- dilution | A fund may incur transaction costs when the fund buys (or sells) investment in response to flows into (or out of) the fund. Anti-dilution describes the mechanism in which a fund passes its transaction costs to the relevant incoming (or outgoing investors). Otherwise, ongoing investors bear the costs of these transactions.
The UK PRIIPs Regulation requires firms to calculate the costs of all transactions completed by the fund, and permits firms to subtract from the total cost, any benefit that the fund gets from anti-dilution. However, this may lead to negative transaction costs being reported in the KID. The treatment of anti-dilution raised concerns that the rules would prevent governance bodies from understanding the effects of the anti-dilution mechanism. |
The FCA now requires firms using the anti-dilution mechanism to disclose anti-dilution benefits in the KID, allowing firms to be more transparent about their costs and the benefit of the effect of anti-dilution.
The FCA further require that the anti-dilution benefit must not be considered if and to the extent that the benefit would take the total transaction costs below zero. The anti-dilution amendments aim to prevent negative transaction costs being disclosed, therefore improving the understanding of retail investors.
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| Calculation of transaction costs for debt securities | The FCA noted that price availability is variable across securities, in particular for over-the-counter transactions in bonds, given that many bonds trade infrequently and that the prices available from data providers may not reflect the most recent market movements.
The terminology used to frame the clarification was confusing and may have excluded electronic bond transactions executed on a trading platform. |
The FCA have published a more accurate and straightforward approach and introduced additional provisions of how transaction costs are to be calculated.
Additional provisions include: – Over-the-counter (“OTC”) transactions. – Non-financial assets. – Situation in which a low number or low value of transactions have been undertaken.
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| Calculation of costs of index-tracking funds
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Index-tracked funds transact differently from actively managed funds, usually undertaking fewer transactions and potentially only transacting in significant volume on a limited number of occasions each year.
Accordingly, slippage is not necessarily the best way of calculating costs.
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The FCA have proposed that index-tracking funds use a spread model to calculate costs, instead of using slippage.
If there is a low turnover, the costs are likely to be low, and a proportionate approach can be justified. If a live fund has a low number of transactions over the previous three years, it will be able to use the spread model.
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| Price of transaction costs
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There has been a lack of clarification as to how the average price of transaction costs is calculated.
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The FCA have introduced rules, to remove uncertainty, however this will be evaluated when HMT conducts a wider review of retail disclosures.
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next steps
The FCA’s changes to the handbook rules and the RTS came into effect on the 25 March 2022. However, the FCA have introduced an implementation period which will end on the 31 December 2022. Firms have until the end of the year to apply the necessary changes.
For more information, and any guidance or advice on changes to UK PRIIPs, Cleveland & Co External in-house counsel™, your specialist outsourced legal team, are here to help.
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