Below is a provocative article, from my colleagues Sunil Chadda and Sandy Trust, discussing two of the major challenges facing PRIIPs regulation.
“Facilis descensus Averno - The descent into Hell is easy.” (Virgil, Aeneid VI.124)
In a well-functioning market, buyers understand both the cost and utility of items for sale, thus making informed value judgements and purchasing decisions. Ergo, the introduction of standards that allow investors to understand the true cost of investing and compare these costs on a consistent basis across the market, as well as comparing the risks and potential returns, can only be a good thing. What a boon not only to competitiveness and a vibrant economy but also to that elusive goal of restoring trust and integrity in financial markets.
In this article, we argue that the recently incepted PRIIPS regulations for investment companies, whilst founded with the very best of intentions, face two very serious challenges:
1. The Patchwork Quilt of Regulation
2. Unintended Consequences
So, the Sisyphean task of unravelling investment costs and charges must continue. You will have your own view of whether PRIIPs represents progress up the hill, or a false start that requires us to start again from the bottom. At least for those involved there is the comforting knowledge that many happy hours of purposeful toil await! Looking briefly at the challenges in turn:
The Patchwork Quilt of Regulation
There are numerous cost transparency initiatives underway, both in the UK and on the continent. Most notably, these include: he European heavyweights of MiFID II and PRIIPs; PS17-20 and the Institutional Disclosure Working Group (IDWG) from the FCA; the Local Government Pension Scheme’s data template; and the forthcoming initiative by the Global Unions Committee on Workers’ Capital (CWC).
But there are inconsistencies between these initiatives. Regulations and cost transparency measures are split in several ways: by asset class coverage, regulator, retail versus sophisticated investor, pension type and other factors - with inconsistencies not only in scope but also in methodology.
From both an investor and a product manufacturer perspective, the regulatory terrain is becoming more costly and difficult to navigate. And as PRIIPs is not being implemented at the same time for all products, comparability issues now need considering. This could result in, for example, different metrics being reported for the same underlying investment due to differences in fund structure.
Because PRIIPs was designed for insurance and UCITS, it is based around a NAV approach to calculating costs, but investment companies also have a share price. This presents a challenge because PRIIPs is completely prescriptive on cost reporting. If the regulations have not clearly identified the cost item, and where and how to report it, then investment companies face a conundrum. Not reporting all costs clearly runs against the spirit of the regulation, yet reporting them may involve changing the calculation methodology, technically a breach of regulation.
PRIIPs also mandates the production of forward-looking performance projections on a 1, 3 and 5 year timeline under four performance scenarios (i.e. Stress, Unfavourable, Moderate and Favourable). These are based on the historical share price movement of the investment company (over a bull market period), not on the nature of the underlying assets. Odd results have been seen, such as one Global Private Equity fund showing a 14.5% p.a. return in an Unfavourable Scenario, which could be viewed as somewhat misleading. (Hence the concerns this link seeks to address.)
Possible outcomes include a more focused regulatory approach, the potential for supervisory action, or an overhaul of the PRIIPS regulations.
The Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation has applied from 1 January 2018. Since then, PRIIP manufacturers have been required to prepare and publish a stand-alone, standardised document, a KID, for each of their PRIIPs. Further, firms that advise a retail investor on a PRIIP, or sell a PRIIP to a retail investor, must provide the retail investor with a KID in good time before the transaction is concluded.