Unruly KIDs Could Spoil UCITS’ Well-Kept Garden

Flowerbeds and Garden Path

Regulators, politicians, and asset managers have divergent views on PRIIPs cost disclosures. However, it is essential that they close out this long-standing debate to avoid disrupting the UCITS ecosystem.

Since their inception, the disclosure requirements within key investor documents (KIDs) have become a long-standing pain point for asset managers caught by the EU’s packaged retail and insurance-based investment products’ (PRIIPs) rules. PRIIPs costs disclosures have been a hotly debated topic and the KID difficulties even reverberated across the Atlantic, discommoding some US ETF providers. The ongoing issues are threefold:

  1. Future Performance Projections: This is a departure from the current practice of disclosing past performance. The industry continues to believe that the new prescribed methodology underestimates upside potential whilst overestimating losses in most cases.
  2. Transaction Cost Methodology: Asset managers are required to estimate transaction costs using what is known as an “arrival price,” which is calculated as the bid/ask midpoint price at the time a trade order is submitted. In general, asset managers do not use the arrival price for anything else in their business.
  3. Regulatory Inconsistencies: The last point of contention is that the rules in PRIIPs are not aligned with other pieces of EU regulation such as MiFID 2, UCITS, and AIFMD disclosures and certain national regulators have bespoke requirements also.

In July, the Financial Conduct Authority (FCA) responded to asset managers’ concerns by suggesting firms made “significant calculation errors” in their cost disclosures and the calculation methodology was not to blame. This reference was specific to a phenomenon known as “negative transaction cost,” meaning instances that may look like the cost of trading is less than zero, which of course cannot be true.

ESMA has consistently suggested they are willing to address PRIIPs performance scenarios and have continued to provide further clarifications in the form of additional Q&A publications.  ESMA, like asset managers, desires consistency in calculation of performance scenarios, so they conducted an industry data gathering exercise to form their own assessments of the methodology. The industry expected ESMA’s exercise would result in concrete amendments and/or clarifications, however to date, ESMA hasn’t taken any action.

So that’s the (extremely) brief history of PRIIPs. Even though the regulation has been fully implemented, it is a story that is far from concluded. One reason the industry has continued to voice its opinion is that KID requirements won’t become applicable to the almost €10 trillion UCITS market[1] until January 1, 2020. So, whilst PRIIPs is currently impacting a sub-set of EU financial products, the largest change will occur when the current disclosures become compulsory for UCITS.

Avoiding UCITS Disruption is a Priority

Earlier this month, the German and Italian national funds associations sent a joint letter on PRIIPs to the European Commission expressing concerns and requesting the Commission conduct their planned review of PRIIPs as soon as possible. Failing this, then they suggested that the current UCITS fund exemption be extended until the end of 2021. This follows other similar letters from the European Fund and Asset Management Association (EFAMA) who also suggested that the numbers in PRIIPs KIDs could be construed as being misleading and would deter investors from investing in funds altogether.

The rules became effective at the start of 2018, and the European Commission had initially proposed a December 2018 PRIIPs review to judge its effectiveness. However, the EU Commission has since announced plans to postpone such review by at least a year to account for delays in the initial PRIIPs implementation. You may recall PRIIPs was originally meant to go live in January 2017, but the industry was given a 12-month reprieve due to question on the final ruleset. This latest delay announcement has reignited expressions of concern among asset managers, who would like the PRIIPS issues to be ironed out sooner rather than later.

What is most important for asset managers, regulators, and politicians is that the issue is resolved for once and for all before the UCITS Funds exemption expires at the beginning of 2020. Otherwise, any planned review may come too late to avoid significant UCITS disruption.

Will the KIDs Be Alright?

Questions remaining are:

  • Is the current calculation methodology framed to provide accurate and understandable outputs of value to investors?
  • Are the specific chosen methods of “arrival price” and “slippage costs” within calculations appropriate?
  • Do the current methodologies increase investors’ understanding of the costs they will incur by investing in a product?

The industry suggests the answer to each question is “no,” and will continue to express their views to both ESMA and the EU Commission – the issue is seen as “mission critical” in the context of potential impact to UCITS funds. And the Commission has every incentive to listen: as a key stakeholder in the debate, they as much as anyone will not want some disruptive KIDs spoiling their beautifully preserved UCITS garden.

[1] EFAMA