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SIX Financial Information

Peter Panse
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We think the PIB regime in place in Germany since 2011 - which requires the disclosure of three scenarios: one positive, one neutral and one negative - has worked reasonably well in practice so that the ESAs should also use this concept for the KID. This approach is easy to understand for investors and has also proved to be both an effective and practicable approach to analyse a very diverse array of products. The performance scenarios should be based on realistic assumptions, as is required by the German regulator as well as by Art. 27 para. 6 lit b of MiFID Level 2 Directive 2006/73/EC, thereby also adding an element of flexibility to the rules.
We do not think that scenarios based on probabilistic modelling would be practicable. They are too difficult for PRIIP manufacturers to implement, require subjective input which ultimately will reduce comparability amongst KIDs from different PRIIP manufacturers and would also require very frequent updates of the KID to reflect changes in probabilities due to market developments.
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A limited number of standard time frames should be established that are applicable for the great majority of the PRIIPs universe, e.g. 1 year for short term investment products and 3-5 years for medium to long term investment products. As these standard time frames might not fit all of the PRIIPs due to the great diversity of PRIIPs, it should also be possible for PRIIP manufacturers to deviate from such standard time frames if they deem it necessary due to the particular characteristics of the individual PRIIP.
We would like to draw the attention to the German experience with PIBs where generally a combination of monetary amounts and percentages is used in performance scenarios.
We agree that for stating monetary amounts often a hypothetical investment amount will be needed that will differ from the amount actually invested by the individual investor. Stating monetary amounts, though, would in our view also most naturally correspond to an answer to the question “What are the risks and what could I get in return?” under which the performance scenarios will be set out.
Further, the investor, having invested a certain amount of money, is primarily interested in what will happen to the invested amount, so he will naturally be more apt to relate to stated monetary amounts. Moreover, the PRIIPs Regulation explicitly allows stating assumptions in connection with the performance scenarios (cf. Article 8 para 3 (d)(iii) of the PRIIPs Regulation), so the hypothetical investment amount should not be problematic. In our view, certain standard investment amounts, e.g. EUR 5,000 or EUR 10,000, should be established, such amounts should adequately cover the majority of PRIIPs thereby enhancing the comparability amongst KIDs. To avoid the preparation of misleading KIDs that need to be corrected afterwards, it should, however, be possible to base the performance calculations on the fixed minimum investment amount applicable to the individual PRIIP if it is higher than the standard investment amount.
In German PIBs, such calculations using monetary amounts are often accompanied by disclosure on the potential rates of return for the three different scenarios in the form of a percentage of the invested amount, which amount also includes costs ultimately resulting in a net performance measure which appears particularly relevant for retail investors (see also our response to question 10.).
Performance scenarios should in our view take costs into account and potential returns should therefore be prepared net of costs (as required by Art. 27 para. 6 lit. c MIFID Level2 Directive 2006/73/EC). As costs of distribution will not be available for all product manufacturers and consequently cannot be reflected in the performance scenarios, it should be possible for the PRIIP manufacturer to carve out such distribution costs from the performance scenarios.
Further, the ESAs should consider developing rules on how distributors should disclose fees, if any, charged by them for the PRIIP, if they provide a KID to a retail investor that does not cover the distribution costs already. Such rules should ideally include the format in which this information is to be provided and how it should interact with the information contained in the KID.
See our response to question 6.
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In our view, the description in the discussion paper on the perspective of the consumer in relation to costs disclosure and the Key Questions is relatively complex and too extensive.
For a short form disclosure document such as the KID the focus should be on a selection of one to three Key Questions that really most interest consumers. We think that the consumer is mainly interested in two question regarding costs: (1) how high are they and (2) how do they impact the amount of his/her investment and his/her potential returns.
The second question could in our view be also addressed in the performance scenarios where it appears to be relatively easy to add an additional column for net return, thereby disclosing how potential returns are affected by costs in the various scenarios. This approach would also help to save space in the KID given that length constraints will in our view be a key issue when all level 2 measures are being finalised.
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One area not reflected in the discussion paper but with a potentially disproportionate effect on PRIIP manufacturers and distributors are grandfathering and transitional rules for products manufactured prior to 31 December 2016.
In our view, it would be impracticable and ultimately disproportionate to require PRIIP manufacturers to produce KIDs for all products issued prior to 31 December 2016. In our view, the ESAs should therefore clarify as soon as possible the extent to which the PRIIPs Regulation is applicable to such products issued prior to 31 December 2016.
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There already exist approaches in the market for the description and presentation of a summary indicator on costs such as the IEV developed by the DDV that is currently being used in Germany. This indicator also includes embedded costs.
We would like to question, however, whether the PRIIPs Regulation is clear in that it requires disclosure of all embedded costs in a structured product. Literally, the PRIIPs Regulation requires the disclosure of both direct and indirect costs. The term “indirect costs” in the PRIIPs Regulation does in our view not necessarily include embedded costs but rather refer to costs which are not directly paid for by the investor towards the distributor/seller. These costs include primarily indirect, ancillary costs such as custody fees to be charged by the custodian bank or stock exchange fees that reduce the amounts payable to investors but are not directly triggered by the PRIIP itself. Embedded costs are typically not separately paid by investors, but are already priced into the terms of the product.
Should the ESAs determine that certain embedded costs included in the terms and purchase price of a PRIIP are to be disclosed in the costs section of the KID, the ESAs should exercise great care in how all of these costs are aggregated and compared, in particular in relation to the description of how costs impact the overall return of investors. If these sections are not carefully designed, investors can easily be misled by false comparisons. For example, embedded costs already priced into a product do not separately reduce the overall potential return after costs when compared to the potential return prior to costs. This is fundamentally different for products in relation to which the investor is separately charged for costs. In relation to these products, the costs will reduce the potential returns prior to costs.
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We do not think that a single risk indicator integrating credit, market and liquidity risk can be developed without causing distorted and misleading results for a number of products due to the diverse universe of products covered by the PRIIPs Regulation. Aggregation of these risks would also blur the meaning of the individual risks and that should be avoided. Instead, we think that either the indicator is limited to describe one key risk, such as market risk, or, alternatively, that it will consist of three separate sub-indicators for each of the three main risk categories.
The risk indicator calculation should also be based on objective, observable data as a model based/subjective criteria based indicator will likely reduce comparability across products from different sectors and different product manufacturers. We also consider that a brief explanation of each of the three risks should be included in the KID.
We would further suggest to consider that the disclosure of liquidity risk in the risk section should be combined with the response to the question How long should I hold it and can I take money out early?" as this question also clearly addresses liquidity risk.
One final point on the timing of the level 2 measures and the required implementation time: Based on our experience as one of the few independent entities specialising in the provision of the German product information leaflet (Produktinformationsblatt; PIB) document for a large number of market participants we know how difficult it is to establish all operational processes to implement the preparation of a single risk indicator such as this. Against this background, we think it is very important to focus on the timing perspective of the RTS on this point. The ESAs should try to focus on establishing the detailed requirements of the risk indicator with priority. If market participants are only able to start their preparatory work on the implementation of the single risk indicator at the end of March 2016, the remaining time will be extremely short to address all operational questions that may potentially arise."
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Given the limited space available in the KID, such information should include the full name of the PRIIP manufacturer, its website and potentially one additional means of communication, such as a telephone number or a postal address.
However, the question of the identity of the PRIIP manufacturer raises substantial issues and questions which require further level 2 guidance.
(1) Under which circumstances does a distributor that charges distribution fees from retail investors change an existing PRIIP in such a way that it thereby becomes a product manufacturer (Art. 4 para. 4 lit. (b) of the PRIIPs Regulation)? In our view, it would be preferable that the costs charged by the distributor be set out in a separate document of the distributor if they are not already included in the KID prepared by the PRIIP manufacturer. This would, however, not mean that the distributor is thereby automatically becoming a PRIIP manufacturer.
(2) Can there be two PRIIP manufacturers for the same product, in particular in cases set out above in para. (1) where the distributor is deemed to have changed an existing PRIIP merely by way of charging costs?
(3) Who should be considered PRIIP manufacturer in the case of product issued by a special purpose entity? Will it be the special purpose entity as issuer or some other party involved and how is it to be determined?
(4) Can a person (Seller) choose to become a PRIIP manufacturer by preparing the KID if the Seller wants to be able to sell such product to a retail investor in the EU in the following situations: (a) If the PRIIP was manufactured by a third party (e.g. if such third party is located outside the EU) who has not prepared a KID; or (b) if the KID prepared by the PRIIP manufacturer is clearly outdated and the PRIIP manufacturer is not required or for any other reason does not to update the KID?
We consider that further guidance should be developed to clearly differentiate between the highly complex products for which the complexity label is warranted and all other PRIIPs.
Without such detailed and clearly defined set of rules, it appears highly likely that PRIIP manufacturers will have difficulty to determine which products are in and which are out-of-scope of the complexity label. Inter alia due to liability concerns they will in such a situation proceed with caution and more often than not include such complexity label.
For example, the approach currently suggested in Recital 18 by referring to several mechanisms being used to determine the final return of the investment is a very broad concept, as a result of which large groups of PRIIPs would be required to include this warning. We are questioning whether the label will have any benefit for the investor if large quantities of PRIIPs or, even worse, the majority of all PRIIPs are required to include this warning. We think it would be preferable to limit it to those products which are particularly complex and where investors are exposed to increased risks.
An inconsistent approach in the application of the complexity label across different jurisdictions and different product segments covered by the PRIIPs Regulation would further dilute the effectiveness of the complexity label. A clearly defined set of rules as suggested above would in our view also be the best way to avoid such inconsistent application of the complexity label across the EU.
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It would in our view be important that the information on consumer types be formulated so that it is compatible with the requirements of MIFID2, including the requirement for product manufacturers to identify the target market of the product in question.
In addition, it would be helpful to receive further clarification on the aspects to be covered in this section in addition to the investor’s loss and investment horizon.
The ESAs should also take into account the limited space availability and should therefore not stipulate too many information requirements for this section.
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We agree, in particular, that actively offered or traded PRIIPs should be monitored for material changes and that the KID should be revised, where necessary, to keep the information in the KID accurate and up-to-date.
However, we think that setting certain intervals for a review of a KID may not always yield the intended results as the information set out in certain sections of the KID may nevertheless become inaccurate due to sudden market developments. In such case, PRIIP manufacturers could still be exposed to civil liability where, for example, a PRIIP is sold based on an old KID in relation to which the review period had not yet expired.
In our view, it would therefore be the simplest approach to specify that the obligation to keep KIDs up-to-date can be satisfied by manufacturers by providing for an automated “dynamic” system of updating KIDs where certain information such as development of the underlying, performance scenarios and payment characteristics are automatically updated during the term of the product. For actively offered/traded PRIIPs, the relevant PRIIP manufacturer could also be required to provide such a dynamic KID on their website.
A manufacturer might not be aware that a PRIIP manufactured by it is being offered/sold on a secondary market. Therefore, there should be clear limits for the obligation of the PRIIP manufacturer to update KIDs where it is not its intention to provide a secondary market for a PRIIP.
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We think that an active communication model such as the one described in the discussion paper would not be appropriate as PRIIP manufacturers often do not have a direct relationship with the investor and it will therefore often be difficult for them to ascertain the identity of the investor in order to reach out to them. Additionally, the updated KIDs will be easily available to investors upon publication on PRIIP manufacturer’s website so that an active distribution model should not be required. For example, in relation to amendments to notes and certificates it is also widely accepted that a publication on a website is recognised as a valid notice to investors.
For the UCITS KII no active information of investors is required in case of an update of the KII. The same line of arguments should also apply to the PRIIPs KID.
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From our perspective, it would be beneficial if the ESAs would commit to develop templates for the whole spectrum of PRIIPs, given that it will increase legal certainty, reduce administrative burdens for the PRIIP manufacturers and can be expected to increase comparability amongst KIDs. On the other hand, we think that the preparation of only a few templates by the ESAs would not have the same benefit and would also lead disproportionally higher risk for manufacturer whose products are not covered by the published templates. If the ESAs are unable to commit sufficient resources to develop templates for the full product spectrum, it would in our view appear to be preferable that the ESAs focus on preparing template wording on specific subsections of the KID which can be used across the whole product spectrum rather than focusing their resources on the preparation of only a few templates. Another alternative could be to standardise terminology used in the KID similar to the German PIB glossary developed for and currently used in the German market.
The decision of the ESAs of whether to develop template KIDs for a wide variety of PRIIPs would materially influence how manufacturers will approach their set-up to the implementation of the PRIIPs Regulation. Given the short time period from the expected finalisation of the level 2 measures in 2016 to the implementation date on 31 December 2016 and the large number of products affected, most market participants will be required to start with the preparation of templates and the technical set-up during 2015 with a view to establish all processes by end 2016.
In order to allow market participants to adequately prepare for the new regime, it would be greatly appreciated if the ESAs could communicate their decision on whether to start work on product templates as quickly as possible during 2015. A long delay in communicating this decision will reduce the available implementation time for market participants and will thus negatively affect their preparatory work on the implementation of the new rules.
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