Topic Consumer protection Key information document: Applicability of the PRIIPs Regulation from the beginning of 2018 now certain
- A real struggle
- Material changes compared to the original draft
- Abstract information for notional target group
- Standardised, neutral and transparent
- Long-term objective of standardisation
- Provision of the KID
- PRIIP financial products with environmental or social objectives
- New tasks for BaFin
- Establishment of a new administrative practice
- European aids to interpretation
On 12 April 2017, the regulatory technical standards for the new key information document (KID) for packaged retail and insurance-based investment products (PRIIPs) were finally published by way of a delegated regulation. These regulatory technical standards contain mathematical and methodological requirements for determining and presenting the core elements of the KID. These include, in particular, the risk and reward profile of the financial product and the summary risk indicator.
The regulatory technical standards are an important condition for the product providers being able to prepare for the mandatory start of the KID obligation (see also expert article "Key information document: PRIIPs Regulation – new, EU-wide standard for production information for consumers" for more information on this). The Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) welcomes the fact that European legislators have managed to give the industry at least six months' time for this.
The delay in work on the regulatory technical standards had led to European legislators finally being forced to postpone by one year the beginning of application of the PRIIPs Regulation by way of an accelerated procedure per amending regulation (see BaFinJournal of January 2017 – only available in German). Consumers are thus entitled to a key information document from 1 January 2018.
A real struggle
The reason for the delay was that the three European Supervisory Authorities (ESAs), the European Commission and the European Parliament had grappled with the contents of the regulatory technical standards. The major difficulty was finding an approach which could be equally well applied to the investment products offered by banks, investment services enterprises and insurers.
After the Parliament had objected in September to some key points in the draft from the ESAs initially approved by the Commission (see BaFinJournal of April 2016 and of October 2016 – both only available in German), the Commission submitted an amended draft. This draft in turn triggered criticism from the ESAs in relation to performance scenarios and PRIIPs which include several investment options (multiple option products – MOPs). For this reason, the ESAs refused to adopt the Commission's proposal. The standards as they are now published represent the best political compromise currently possible.
Material changes compared to the original draft
There are three material changes compared to the draft originally submitted by the ESAs. Firstly, in performance scenarios a stress scenario must now also be presented, which is intended to sharpen the consumer's awareness of the worst case scenario. The formula for the other three performance scenarios remains unchanged.
Secondly, in the case of PRIIPs consisting of UCITS (undertakings for collective investment in transferable securities) funds as their target investment, PRIIP manufacturers may, up until the end of 2019, also choose to determine the information to be included in the key information document on the basis of the calculation methodology for the key investor information document for UCITS – without having to point this out to the consumer. In practice, the difference is likely to be rather small in the case of PRIIPs without guarantees. However, guarantees at contract level can only be presented adequately if the manufacturer applies the PRIIPs methodology throughout.
Finally, from now on all key information documents for PRIIPs which are considered complex under the criteria of the European Markets in Financial Instruments Directive II (MiFID II) and the Insurance Distribution Directive (IDD) and are therefore not sold on an execution-only basis must include the following comprehension alert: "You are about to purchase a product that is not simple and may be difficult to understand."
BaFin expects, however, that the changes will be examined critically once more during the review of the PRIIPs Regulation which is due to take place over the coming year. This applies in particular to the comprehension alert, which was neither subject of the original PRIIPs mandate of the ESAs nor of any impact study or consultation.
Abstract information for notional target group
From 2018 onwards, every retail investor who would like to inform themselves on a PRIIP must be provided with the relevant KID. This applies irrespective of which distribution channel they choose and whether or not they actually decide in the end to make an investment.
Such investors can therefore not expect the KID to be personally tailored to them. Instead, the information is abstract in nature and is addressed to a notional retail investor of a specific target market. Whether an individual retail investor belongs to the correct target group must be clarified by the seller.
It is the manufacturer of the PRIIP, i.e. any entity that manufactures the PRIIP or that makes changes to an existing PRIIP's risk and reward profile or the costs associated with an investment in a PRIIP, who is responsible for ensuring compliance with the obligation to publish a KID. This responsibility cannot be delegated, even in the event of outsourcing.
Standardised, neutral and transparent
When conceiving the key information document, European legislators took account of the principles of behavioural economics. It is intended to inform retail investors in a neutral and transparent manner and thus assist them in their decision to invest (or not) in a PRIIP.
There are standardised requirements for content, layout and order. The core contents are to be presented in question-and-answer format. Important here are an assessment of risk, the presentation of different performance scenarios (including a stress scenario) and the disclosure of all one-off and recurring, explicit and implicit costs (e.g. transaction costs).
In particular for one-off and recurring costs, this means a whole new level of disclosure to the consumer. Only the disclosure of costs of distribution may remain incomplete, since the manufacturer can only be obliged to disclose these if and when they are aware of them. In order that no misunderstandings arise, each KID contains a corresponding indication. In addition, the distributor must usually disclose their own remuneration.
It is also important that KIDs do not include any marketing content and may not be supplemented with information that serves advertising purposes.
Long-term objective of standardisation
Ideally, use of the standardised KID will lead to a situation where consumers gradually develop certain expectations with regard to product information, which will become an integral component of general financial education.
Through standardisation of the key information document and limitation of its length to a maximum of three A4 pages, the undertakings in turn are forced to look at their own products more intensively, as they have to compare them directly with the PRIIPs of other European manufacturers. Together with the requirements for the product release procedure stipulated in section 33 of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG (only available in German)) and section 23 of the planned amendment to the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG (also only available in German)), the obligation to publish a KID will potentially also lead to undertakings critically examining their own product range as well as asking themselves what innovations can be offered. Ideally, standardisation of product information could therefore initiate a trend towards consumers essentially only being offered products that are simple and easy to understand.
Provision of the KID
The KID must traditionally be made available on paper. If requested, the consumers must also be able to receive it electronically, i.e. by e-mail or via the manufacturer's website. Displaying information from the KID by app is also possible; however, it does not satisfy the providers' obligations in relation to the KID.
The regulatory technical standards stipulate that the manufacturer update the KID on their website at least once a year. In addition, it is always to be adapted without undue delay if there are changes to the summary risk indicator, the performance scenarios or the costs.
The key information document is only used if the investor is making the investment decision for themselves. Investors who have entrusted the management of their assets to a portfolio manager therefore do not received any KID.
PRIIP financial products with environmental or social objectives
Under the heading "What is this product?", PRIIP manufacturers can indicate, amongst other things, whether a financial product has certain environmental or social objectives. This takes account of the fact that the intended purpose of a financial investment is of increasing importance for consumers' investment decisions. The Joint Committee of the ESAs is currently developing Technical Advice so that consumers can also trust the information provided in this regard in the KID. It published a first consultation in February and March of 2017. It is currently revising its advice. The ESAs will send the final version to the Commission on 31 July; a delegated regulation is expected to be adopted in autumn or winter.
The Technical Advice will not create any generally applicable classification in the form of a label for PRIIPs with environmental or social objectives. The products, as well as the wishes of the consumers, are too heterogeneous across Europe for this. The core element will therefore more than likely be the recommendation to introduce an investment policy statement which informs the consumer in precise terms about the product's environmental or social objectives as well as showing what strategy will be used to achieve this and what control mechanisms are in place. Furthermore, the particular intended purpose should be specifically taken into account in the product release procedure requirements within the respective undertaking.
New tasks for BaFin
In Germany, the provisions of the PRIIPs Regulation have been anchored in the respective supervisory legislation through the First Financial Markets Amendment Act (Finanzmarktnovellierungsgesetz) (only available in German) (see expert article "Sanctions: First Act Amending Financial Markets Regulations – the new provisions of the German Securities Trading Act". This provides BaFin with the powers to intervene and impose sanctions which it requires to monitor the obligation to produce and distribute a KID as well as the obligation to comply with all associated requirements. BaFin fulfils its duty by way of a risk-based supervision of violations of consumer protection law, since systematic monitoring of the KIDs is not anchored in the Regulation.
In particular, it is not envisaged that BaFin has the KIDs submitted in advance (ex ante notification). Recital 11 and Article 5(2) the PRIIPs Regulation state that the EU member states are free to introduce such ex ante notification and thus create the opportunity to counter violations systematically before they occur.
Establishment of a new administrative practice
The technically very demanding PRIIPs regulatory technical standards require interpretation and the establishment of a new administrative practice by BaFin, which goes beyond its previous approach to product information sheets. Both the undertakings and BaFin itself are still lacking in experience with the new key information documents. For this reason, dialogue between BaFin and the financial industry is very important.
BaFin basically has scope for discretion in exercising its new powers. However, if a PRIIPs provider violates their obligation to provide a key information document, BaFin will as a rule have to intervene.
European aids to interpretation
Because of the EU-wide significance of the PRIIPs Regulation, coordination at the European level, especially in the form of aids to interpretation which can then be supplemented through national interpretative decisions, is essential.
The Commission plans to respond soon to different outstanding questions on the PRIIPs Regulation in the Official Journal of the European Union. In particular, information on the material and substantial scope of the Regulation, the competence of the authorities in the area of cross-border business, responsibilities for PRIIPs from third countries as well as questions relating to the beginning and end of the obligation to publish a KID are expected.
The ESAs for their part will afterwards (before the summer) publish questions and answers on specific contents of the regulatory technical standards. These will relate above all to the technical requirements on risks, reward profile and costs, the depth of detail required in the information provided as well as specific questions on derivatives. More questions and answers are intended to follow gradually.
In other respects, too, however, an end to work on the KID at the European level should not be expected so quickly. This is because the PRIIPs Regulation provides for the EU Commission presenting its recommendations for revision of the Regulation at the end of 2018 already.
Here, there is the chance to adjudge whether the KID has proven itself in practice, whether it is seen as beneficial by the consumer and to what extent it may need to be adapted in terms of its presentation and language. From BaFin's point of view, it would be desirable that, here too, insights gained from consumer studies are considered early on and that the idea that consumers may be better served with a leaner KID to help them take their first steps towards an investment decision – even for more complex products – is not seen as a taboo. BaFin also sees room for improvement in terms of the terminology used in the template, which should be based more on recognised principles of consumer-friendly language.
The question of to what extent the KID is suitable for an even wider scope will also have to be clarified. By the end of 2019 at the latest, when the exemption for UCITS funds expires, a new KID concept should be available. This should then take account of more recent technical developments by making the key information document app-capable, for instance, and enabling its use in online comparison databases.