Packaged retail and insurance based investment products (PRIIPs)

Transcription

1 Packaged retail and insurance based investment products (PRIIPs) Making the complex simple

2 Summary box PRIIPs regulations are to be introduced in less than one year. From 31 December 2016, a KID (key information document) will be required for virtually all investment products (including insurance savings and insurance based pension products). There is significant work and complex calculations involved in preparing a KID, particularly in the areas of categorising products and determining the risks and rewards for policyholders and investors. Insurers, fund managers and product providers need to prepare now for the new regime.

3 Making the complex simple From 31 December 2016, manufacturers and distributors of packaged retail and insurance based investment products (PRIIPs) will have to comply with EU Regulations on key information documents (KIDs) for PRIIPs. These Regulations were passed by the European Parliament on 26 November The Regulations oblige manufacturers and distributors of products that fall under the regulations to provide a short document, the KID (which must meet very specific requirements), that clearly describes the product features and risks to retail investors before they invest. This note provides a high-level overview of PRIIPs developments to date but focuses on the Joint Consultation Paper that was recently issued by the Joint Committee of the European Supervisory Authorities (ESMA, EIOPA and EBA) 1 and the issues arising. Background Across the EU, each member state has its own regulations for disclosing pre-sale and post-sale product information. Even within some member states, there are differing rules between products sold as insurance and those sold as unit fund investments. The purpose of the PRIIPs regulation is to harmonise the pre-and post-sale information across all product vehicles and across the EU. Given the range of products in each market and the different vehicles for packaging these investments, this is no easy task. What is a PRIIP? The legislation applies to any product that satisfies the definition of a PRIIP. A PRIIP is defined as investment where...the amount repayable to the retail investor is subject to fluctuations because of exposure to reference values or to the performance of one or more assets that are not directly purchased by the retail investor. This includes insurance based investment products which offer a maturity or surrender value that is wholly or partially exposed, directly or indirectly, to market fluctuations. It is worth noting that direct investments (such as direct investments in equities, government bonds and so forth) and occupational pensions are out of scope (although the definition of occupational pension is unclear). Similarly, bank deposits that only have an exposure to interest rates are out of scope. UCITS currently have their own regulations, but will be brought under the PRIIPs regime by 31 December Joint Consultation Paper on PRIIPs Key Information Documents. Draft regulatory technical standards with regard to presentation, content, review and provision of the key information document, including the methodologies underpinning the risk, reward and costs information in accordance with Regulation (EU) No 1286/2014 of the European Parliament and of the Council. 1 Packaged retail and insurance based investment products (PRIIPs)

4 Figure 1. PRIIPs coverage Products covered Structured instruments Non-UCITS unitised funds Hedge funds Unit-linked insurance policies With-profits insurance Products not covered Occupational pensions Non-life insurance (for example motor) Term assurance UCITS Direct investments/bank deposits (linked to interest rates) Who is responsible for preparing and delivering the KID? Every product manufacturer or re-manufacturer (that is, where an existing PRIIP is repackaged) will be responsible for drawing up a KID for that product in accordance with requirements set out in the regulations. In addition, post-sale the KID should be regularly reviewed and revised as required. The responsibility for delivering the KID lies with the person advising or selling the PRIIP to the investor. This could be the KID manufacturer or the distributor. What does a KID look like? The legislation sets out the format of the KID and the required content. This is summarised in the table below. The KID should be provided free of charge (either on paper or website) and in good time before the conclusion of the contract, but with the possibility of delivering immediately after the conclusion of the transaction if distance communication has been used. Figure 2. Format of KID Length Language Content What is the product? What are the risks and what could I get in return? What happens if the manufacturer is unable to pay? What are the costs? How long should I hold it and can I take the money out early? How can I complain? Other relevant information Maximum of three A4 pages Type of product Its objectives Member state of where the product is being sold Description of the risk-reward profile including a summary risk indicator (SRI) Possible loss of entire investment Potential investor compensation scheme payment (if relevant) Direct and indirect costs One-off and recurring costs Summary risk indicators Cooling-off period Minimum holding period Consequences of early termination Manufacturer s complaints process Industry complaint resolution body (if relevant) Any additional information to be provided (not marketing material) 2 willistowerswatson.com

5 What are the latest developments? On 11 November 2015, the latest in a series of Joint Consultation Papers was issued by the European Supervisory Authorities (ESAs), covering regulatory technical standards on risk, reward and costs to be disclosed as part of the KID. This Consultation Paper includes: A. Presentation and content of the KID B. Methodologies for calculating risks and rewards C. Rules around the review, revision and republication of the KID D. Conditions for providing the KID in good time The first two points have been areas of much discussion between the various stakeholders involved in the PRIIPs development process. The Consultation Paper contained 28 questions and the deadline for responses was 29 January Any interested parties can respond through the website of the ESA 2. A. Presentation and content of the KID The main development in this section of the Consultation Paper was that the ESAs proposed two possible approaches for products offering multiple investment options: Approach 1: the PRIIP manufacturer would produce separate KIDs for each option, containing information about the PRIIP in general and about the option in particular. Approach 2: the PRIIP manufacturer would instead produce a generic KID for the PRIIP in general, and then provide specific information about the options (including their description, their risks and rewards, and their precise costs) within a separate document or documents. No examples were produced so it is not clear at this stage what these documents would look like. The uncertainty around this remains a concern for product providers. B. Methodologies for calculating risks and rewards A significant proportion of the Consultation Paper covered methodologies for calculating risks and rewards: The ESAs propose to group products into five separate categories as follows: Figure 3. Categories of products Category Definition Type of product I Products with unconditional capital protection (less than five years) OR where investor could lose more Guaranteed bond with counterparty being manufacturer than invest OR derivatives II UCITS/AIFs or similar with history of two years of daily Unit-linked? pricing or four years of weekly pricing III Not Category I/II/IV but where 500 days of historical Structured products data is available IV Products containing factors not directly observable With-profits in market V Products which would fall under Category II/III but lack data New UL or structured product? The Type of product column represents our current understanding of which products fall into which category. It should be noted that in some cases it is unclear. 2. Mttps:// 3 Packaged retail and insurance based investment products (PRIIPs)

6 To be placed under Category I, there should be a guaranteed repayment of the initial investment amount up to five years maturity. The Consultation Paper states that there should be unconditional protection of capital. It is not clear from the Consultation Paper what this means. Under Category II, AIFs, UCITS and other PRIIPs, acting in a similar capacity as AIFs or UCITS and investing into the same type of underlying assets such as units offered within unit-linked insurance products where applicable. To qualify they need to have two years of daily historical pricing or four years of weekly historical pricing. A natural proxy can be used if such a proxy exists. However, there is little detail in the Consultation Paper as to what qualifies as a proxy. Category III includes any UCITS/AIFs not falling under Category II and any guaranteed PRIIP not falling into Category I or IV. This includes structured products. These need 500 daily historical prices to be available over the last five years. Where this is not available, it is assigned to Category V. Category IV covers PRIIPs where the value depends in part on the factors not observed in the market. With-profits products are specifically mentioned. Category V covers the situation where there is insufficient data or the underlying investments are illiquid. Each PRIIP will be allocated a summary risk indicator (SRI). This will be composed of a Market Risk Measure and (in some cases) a Credit Risk Measure. Figure 4. Risk rating class Category Class Example I Capital guarantee = 1 Other = 7 II VaR = 2.5% converted to Vol based on historical returns 1 = Vol <0.5% pa 7 = Vol >2.5% pa Products containing factors not directly observable With-profits in the market III VaR =2.5% converted to Vol but based on As II bootstrapping (10,000 sims) IV Similar to III but allow for non-market factors Unclear V Allocated according to type Money market fund = 1 Equity fund = 5 4 willistowerswatson.com

7 Market Risk Measure (MRM) The MRM depends on the product category in which the PRIIP sits, as follows in Figure 4. For Category I business, the MRM is 1 if there is an unconditional capital guarantee, otherwise it is 7. Category II involves calculating the moments from the five years of historical data. The moments are then used to calculate a Value at Risk (VaR) at the 2.5th percentile (using a particular equation). Using another equation the VaR-equivalent volatility or VEV is calculated. The PRIIP is assigned an MRM based on the table below. These MRM classes are similar to those applicable to the UCITS KIDs. Figure 5. MRM MRM class Annualised volatility 1 <0.5% 2 0.5% - 2% 3 2% - 5% 4 5% - 10% 5 10% - 15% 6 15% - 25% 7 >25% Category III requires a stochastic calculation with a minimum number of 10,000 simulations. It uses a bootstrapping technique whereby individual simulations are selected randomly from the daily returns over the five year history. These are used to project the value at maturity. The value at the 2.5th percentile of outcomes is chosen as the VaR and this is converted to a VEV as with Class II and assigned to an MRM as per Figure 5. Category IV mentions that bootstrap factors should be used for market factors. However, these should be overlaid by non-market factors following industry standards. There is a lack of clarity as to what this means in the Consultation Paper. Category V (no historical performance data or proxy available) provides predetermined MRMs for different fund types as follows: Figure 6. Category V MRM Product/PRIIP type MRM class Money market funds 2 Government bond funds 3 Corporate bond funds 4 Broad equity-based funds 5 All other funds, structured PRIIPs which 6 do not fall into Category I Private equity funds (according to the Alternative Investment Fund Managers Directive (AIFMD) or similar are given a class of 6. Illiquid funds are given various ratings depending on the proportion which is deemed to be illiquid. For many PRIIPs it is evident from the proposals that quite a complex approach will have to be taken. 5 Packaged retail and insurance based investment products (PRIIPs)

8 Credit Risk Measure (CRM) For certain categories other than UCITS/AIFs, a credit risk indicator needs to be calculated. The credit risk is calculated on the entity providing payment. Where there are several layers, the credit risk must look through to the underlying provider. However, where there is a third party guarantor, its credit risk is assessed. The credit rating is assessed using credit rating agencies but mapped to six credit classes. Where there is an unrated counterparty, the credit risk is mapped to 5. Unrated counterparties that are regulated EU institutions receive a rating of 3. Once the CRM has been calculated, the SRI is established by reading across the table below: Figure 7. SRI MRM CRM If a product is deemed to have a liquidity risk, an additional warning should be placed within the KID. The format for the presentation of the SRI is set out below. The Consultation Paper proposes additional wording below this, but this is not reproduced here (refer to page 49 of the Consultation Paper) Lower risk! Performance scenarios Higher risk [The risk can be significantly different if you cash in at a time other than the end of the recommended holding period.] [It may not be possible for you to cash in early, or, if you do so, you may incur additional costs or losses.] The Consultation Paper proposes that there will be three performance scenarios, namely: An unfavourable scenario A moderate scenario A favourable scenario It also states that an additional scenario should also be provided if the unfavourable scenario does not cover significant downward impacts (for example, nonlinear outcomes). For insurance based investment products, an additional scenario should be provided showing the return where an insured event occurs. The performance scenarios themselves are not defined (for example rates of return and so forth). However, there are some principles set out, such as references to market data, peer groups or benchmark data, balanced presentation of outcomes, not unreasonably optimistic, along with others. The lack of more specific maxima and minima for product projections runs the risk that misleading projections could be provided. 6 willistowerswatson.com

9 The scenarios should be calculated for the recommended holding period but also for earlier periods where it is possible to obtain an earlier encashment value. The projections should be based on 1,000 for investment funds and PRIIPs other than insurance based investment products. For single premium insurance based investment products the investment should be 15,000, and 1,000 per annum for regular premium-based products. The use of fixed investment amounts could be problematic as it may overstate or understate the effect of fixed costs if the actual amounts of investment are higher or lower. In addition, some of these fixed investment amounts could be below the amount permitted by the contract. Projections should be net of all costs disclosed. The Consultation Paper sets out a sample of the projection tables: Figure 8. Projected values Investment Scenarios [1] year [3] years [5] years (recommended holding period) Unfavourable scenario Moderate scenario Favourable scenario What you might get back after costs Average return each year What you might get back after costs Average return each year What you might get back after costs Average return each year Accumulated invested account Disclosed costs The Consultation Paper sets out a very comprehensive list of costs to be disclosed. These are not repeated here but a couple of noteworthy points arise: The costs of any capital guarantees should be included. Performance fees should also be included. Transactional costs must be included. These are based on the average transaction costs over the previous three years of the PRIIP s existence or a suitable proxy. There is look through to the costs where there are underlying packaged investments used. The cost part of biometric premiums (that is, in excess of the best estimate of the cost of the risk) should be disclosed. (Refer to Annex VI of the Consultation Paper for more detail.) A reduction in yield calculation is also required and is to be presented along with the total costs in a table as shown below: Figure 9. Disclosure of costs Investment [ 1,000] If you cash in after [1] year If you cash in after [3] years One-off costs + Recurring costs + Incidental costs = Total costs RIY % % % If you cash in after [5] years (recommended) 7 Packaged retail and insurance based investment products (PRIIPs)

10 Figure 10. Subdivision of costs One-off costs Recurring costs Entry costs % Exit costs % Portfolio transaction costs per year Other recurring costs per year % % Incidental costs Performance fees % Impact of entry costs taken before investment. [This is the maximum; you could pay less.] Impact of exit costs taken when you exit the investment upon maturity. Impact of recurring costs taken from your investment each year. [The figures shown are based on our costs for last year. The figures shown are an estimate of what the costs could be.] The figures cover all recurring costs, including annual management costs, operating expenses, and portfolio transaction costs. Impact of performance fees taken where the performance... C. Rules around the review, revision and republication of the KID The Consultation Paper sets out that the KID should be reviewed every 12 months or if a significant event occurs. It does not specify what constitutes a significant event but the expectation is that companies would have sufficient procedures in place to cope with this. It also covers the situation where a product is no longer being sold; a KID does not have to be prepared where the PRIIP is not available to investors. This seems to imply that existing products which are closed to new business do not need to have a KID. However, the position regarding top-ups to existing products is not clear. D. Conditions for providing the KID in good time The person advising on, or selling, a PRIIP needs to provide the KID in good time, whereby they provide the document sufficiently early for the retail investor to read and consider before being bound by any contract or offer relating to that PRIIP. Next steps Responses to this latest Consultation Paper were due by 29 January Further regulatory technical standards are expected during 2016, with final implementation scheduled to be 31 December Insurers, fund managers and other relevant product providers need to be considering: How to model products and funds to determine their risks and reward profile Gathering the information required The tools necessary to produce the information to be included in the KID The impact of these new regulations on the design of existing and potential new products The sales process The effect on current disclosure software and IT systems. Willis Towers Watson has been monitoring the PRIIPs developments closely and is well-positioned to assist you in all areas of the implementation of the PRIIPs regime. Further information For further information, please contact your Willis Towers Watson consultant or Colin Murray colin.murray@willistowerswatson.com 8 willistowerswatson.com

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12 About Willis Towers Watson Willis Towers Watson (NASDAQ: WLTW) is a leading global advisory, broking and solutions company that helps clients around the world turn risk into a path for growth. With roots dating to 1828, Willis Towers Watson has 39,000 employees in more than 120 countries. We design and deliver solutions that manage risk, optimise benefits, cultivate talent, and expand the power of capital to protect and strengthen institutions and individuals. Our unique perspective allows us to see the critical intersections between talent, assets and ideas the dynamic formula that drives business performance. Together, we unlock potential. Learn more at willistowerswatson.com. Willis Towers Watson 71 High Holborn London WC1V 6TP Towers Watson is represented in the UK by Towers Watson Limited. The information in this publication is of general interest and guidance. Action should not be taken on the basis of any article without seeking specific advice. To unsubscribe, eu.unsubscribe@towerswatson.com with the publication name as the subject and include your name, title and company address. Copyright 2016 Towers Watson. All rights reserved. WTW-EU-16-PUB-1739 willistowerswatson.com