The aim is to strengthen investor protection and restore retail investors' confidence in the financial market with increased transparency. The provisions are to be used in all EU Member States as of 31 December 2016.

The three European Supervisory Authorities (ESAs) EIOPA, the EBA and ESMA have to present draft Regulatory Technical Standards to the European Commission by 31 March 2016 regulating the details of how the key information is to be calculated and presented in the KIDs. They released a Technical Discussion Paper for consultation in mid-June. This covers the presentation of risks, performance scenarios and cost disclosures in key information documents.

This article discusses the content of and background to the new rules brought about by the PRIIPs Regulation. It also provides detailed information on the proposals which the ESAs consulted upon.

New European standard

Both nationally and internationally, the financial crisis was partly a crisis of confidence on the part of consumers and investors. The ESAs have the job of taking appropriate measures to restore this confidence.

In general terms, the introduction of duties to provide information by one of the contracting parties has the economic objective of balancing out information asymmetries. Specifically, this means that consumers – whether they are retail investors, policyholders or bank customers – must have as much information as possible before they sign a contract so that they are not at a disadvantage to the provider. Since consumers of financial services are dealing with an abstract economic good, pre-contractual information plays an important role. It helps them to make the right decision. If a consumer concludes a contract without being adequately informed of the economic advantages and disadvantages of the product and his or her related rights and obligations, it could lead to a mistaken purchase and thus also to considerable risks for the consumer.

The increasing complexity of the markets, technological changes and the higher number of cross-border transactions are the primary reasons for the need to better inform consumers. However, also the increasing variety of offers and products which are getting more and more complex have a major influence on consumers' increasing need for comprehensive information as well. This has led to collective protection for consumers becoming an increasing focus for politicians and the public. The best example of this is the German Retail Investor Protection Act (Kleinanlegerschutzgesetz, only available in German), which recently came into force.

Packaged investment products

The somewhat cumbersome acronym PRIIPs is used for Packaged Retail Investment and Insurance-based investment Products which are subject to an investment risk. Primarily, these include:

• structured financial products, such as options, which are packaged in insurance policies, securities or banking products;
• financial products whose value is derived from reference values such as shares or exchange rates (derivatives);
• closed-ended and open-ended investment funds;
• investment-type insurance products, such as with-profit and unit-linked life insurance and hybrid products; and
• instruments issued by special purpose vehicles.

The scope of application has been kept deliberately broad to take account of the heterogeneity of financial products in the EU Member States. This prevents providers circumventing the Regulation by using a particular legal form, name or intended purpose for the financial product.

The definition of packaged investment products is only restricted by the exclu-sion of certain products. In particular, insurance contracts without an invest-ment element, such as term life insurance policies and non-life insurance products (e.g. property and casualty insurance²), occupational pension products, non-structured deposits and so-called "Riester" products are excluded. Investment products without derivative components, such as shares and bonds, are not included either.

Key information documents

Potential investors must be provided with the key information documents on PRIIPs before they sign the contract. KIDs are intended to enable retail investors in the EU to better understand the key features and risks of PRIIPs. In addition, the provisions for PRIIPs key information documents are supposed to make such products better comparable Europe-wide, both within a sector – for example, different life insurance policies – and between different sectors – for example, so that a life insurance policy can be better compared with an investment in an investment fund.

PRIIP manufacturers are responsible for drawing up the key information document. The manufacturer could be a legal entity or a natural person who issues a PRIIP or makes changes to the risk and reward profile or the associated costs of an existing PRIIP.

Key information documents should generally be written using language which is easy for the retail investor to understand and follow a question-and-answer format (e.g. "What is this product?"). They should be a maximum of three pages of A4-sized paper long and must be written in the official language used in the EU Member State where the PRIIP is distributed. They must also be separate documents which are clearly distinguishable from the manufacturer's advertising material. The manufacturer must publish them on its website and is responsible for keeping them up-to-date.

Contents

First of all, the key information documents must contain information about the risks of the investment product. The PRIIP manufacturer should describe these and present them using a summary risk indicator. It should also discuss the possible rewards and in particular the possible maximum loss of invested capital as well as various performance scenarios and the underlying assumptions.

The costs associated with the PRIIP must be clearly presented to the consumer in the key information document as well. Direct and indirect, one-off and recurring costs must be presented in a summary cost indicator. This should give the costs expressed in monetary and percentage terms to ensure that different products can be compared.

The key information document must also include a clear indication that advisors, distributors or any other person selling the PRIIP will provide information detailing any cost of distribution that is not already included in the direct and indirect costs specified.

Technical Discussion Paper

The Technical Discussion Paper published by the ESAs contains proposals for the methodologies and mathematical models to present the risk-reward profile in the key information document and to calculate the summary cost indicator. The ESAs had already carried out a more general consultation in November 2014. The idea now is to determine specific methodologies and presentation options at the technical and mathematical level. Market participants had until 17 August 2015 to submit their comments.

In autumn, the ESAs will carry out a consultation on the Regulatory Technical Standards and subsequently present them to the Commission, which ultimately issues the standards, by 31 March 2016.

Consumer testing

Parallel to the development of the Regulatory Technical Standards, consumer surveys and testing are currently taking place across Europe. The results of these will form the empirical basis for deciding on the standards. The results of the surveys will be the final determining factor for the presentation of the various indicators in the key information documents.

The background to this is a study on the content and design of the key information document ordered by the European Commission.

Summary risk indicator

The summary risk indicator provides information about the risks incurred by the consumer through the investment. The market risk, i.e. the performance of the investment, the credit risk, i.e. the risk of a default by the PRIIP manufacturer, and the liquidity risk, i.e. the risk that the PRIIP is no longer tradeable and thus can also no longer be cashed in, are presented.

The Technical Discussion Paper explains three methods which could be specified for manufacturers to calculate the summary risk indicator: a largely qualitative valuation approach and two more demanding model-based assessment methods. The decisive factor for the consumer is ultimately that the product's risk is clearly identifiable. This could be displayed on a scale from 1 to 7, for example. This form of presentation is similar to that of the Synthetic Risk Reward Indicator for certain investment funds, the so-called undertakings for collective investment in transferable securities (UCITS), but the underlying methodology is different.

However, at the moment there are also other possible methods of presentation and assessment under discussion. The ESAs want to wait for the comments of those participating in the consultation and the consumer testing on this issue.

Example for the presentation of the summary risk indicator

Example for the presentation of the summary risk indicator

BaFin

Performance scenarios

As far as performance scenarios are concerned, the discussion paper deals with two general options for presentation, one of which will become binding in the Technical Standard. One of these is "what if" scenarios, in which the consumer is shown the expected rewards from different scenarios, for example an optimistic, a pessimistic and a medium scenario. However, the scenarios do not have to be presented in a table but can be given in a diagram instead.

Alternatively, the consumer could have scenarios based on probabilities explained to them. In this case, too, however, other methodologies and presentation options are conceivable. The final decision of the ESAs will be based on the results of the consumer testing and the consultation.

Source: ESAs

National provisions

In Germany, product information documents already have to be produced for certain financial products. The basic principles and the type of information on the key elements of the contract required by these existing national product information documents are similar to the European requirements for PRIIPs KIDs.

Insurers, for example, have to provide clients who are consumers with a product information document pursuant to section 4 of the Regulation on Information Obligations for Insurance Contracts (Versicherungsvertragsgesetz-Informationspflichtenverordnung – VVG-InfoV). It must contain the information that is of particular significance to the conclusion or performance of the insurance contract. Insurers have to issue a separate product information document for each insurance class. For life insurance, occupational disability insurance and health insurance there are additional, detailed obligations to provide information, in particular with regard to costs.

In addition, pursuant to section 7 of the Insurance Contract Act (Versicherungsvertragsgesetz – VVG), insurers have to give all potential customers the contract terms including the general policy conditions. They also have to provide certain information specified in the VVG-InfoV namely about the insurance undertaking itself, the service offered, the contract and options for legal protection. In practice, insurers fulfil their obligations to provide information by giving their customer general legal information on the company, contract and the options to cancel and for legal protection in the form of "consumer information" and add a description of the content of the contract and the terms of the specific insurance contract to the general policy conditions.

In the field of securities supervision, there are also various obligations to provide information documents, which are largely based on European law. For example, the German Investment Code (Kapitalanlagegesetzbuch – KAGB) prescribes that retail investors must receive key information about their investments. Pursuant to section 31 of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) providers of financial instruments also have to have an information document available. This obligation was introduced in 2011 by the German Investor Protection and Capital Markets Improvement Act (Anlegerschutz- und Funktionsverbesserungsgesetz – AnsFuG). It also applies to capital investments (section 1 (2) no. 4 of the German Capital Investment Act – Vermögenanlagengesetz – VermAnlG) and UCITS, i.e. undertakings for collective investment in transferable securities (sections 164 and 166 of the KAGB).

There is currently no legal requirement to prepare product information documents for other banking services, such as structured deposits. However, some institutions provide them on a voluntary basis. The German Derivatives Association (Deutscher Derivate Verband – DDV) has developed sample product information documents for structured products.

For private old-age provision products with tax benefits, i.e. Riester and basic pension products, a product information document known as a "Riester-PIB" was introduced in section 7a of the Act Governing the Certification of Contracts for Private Old-Age Provision (Altersvorsorgeverträge-Zertifizierungsgesetz – AltZertG) by the Old-Age Provision Improvement Act (Altersvorsorge-Verbesserungsgesetz – AltvVerbG) of 2013.

Differences

The key information documents pursuant to the PRIIPs Regulation differ from the German product information documents based on national legislation in particular due to the fact that risks and costs are not to be presented in text form but instead are to be represented in the form of indicators. Indicators require parameters to be determined. In consequence the preparation and monitoring of key information documents pursuant to the European Regulation is considerably more demanding both for the industry and supervisors. The model to learn from is that of the key investor information document (KIID) for UCITS, which is also based on European specifications and prescribes a risk indicator to depict the market risk.

A new feature in contrast to the existing product information documents is the obligation to add the following comprehension alert to key information documents for particularly complex PRIIPs: "You are about to purchase a product that is not simple and may be difficult to understand."

Moreover, a central point strengthening consumer protection is that the PRIIP manufacturer may be held liable if a retail investor suffers damage as a result of a key information document which does not meet the requirements of the PRIIPs Regulation and he or she has therefore made an incorrect investment decision. The Regulation places the burden of proof in a legal dispute on the manufacturer, which must show that the key information document complies with the PRIIPs Regulation.

It is to be expected that the German legislators will take the PRIIPs Regulation as an opportunity to reorganise the statutory product information document landscape. They need to ensure that manufacturers, issuers and providers only need to prepare one product information document for each of their products and thus that consumers receive no more than one information document per financial product.

Footnotes

¹ Regulation on key information documents for packaged retail and insurance-based investment products.

² The planned recast of the Insurance Distribution Directive envisages that a product information document will have to be made available for property insurance policies in Europe as well.