17 August Joint Committee of the European Supervisory Authorities

Transcription

1 17 August 2015 Joint Committee of the European Supervisory Authorities European Banking Authority One Canada Square (Floor 46) Canary Wharf London E14 5AA, UK European Securities and Markets Authority 103 rue de Grenelle Paris Cedex 07, France European Insurance and Occupational Pensions Authority Westhafenplatz Frankfurt am Main, Germany Submitted via electronic submission RE: Technical Discussion Paper (TDP) on Risk, Performance Scenarios and Cost Disclosures In Key Information Documents for Packaged Retail and Insurance-based Investment Products (PRIIPs) Dear Sirs, BlackRock, Inc. ( BlackRock ) [1] is pleased to have the opportunity to respond to EIOPA s TDP on Risk, Performance Scenarios and Cost Disclosures In Key Information Documents for Packaged Retail and Insurance-based Investment Products (PRIIPs). As a fiduciary for our clients, BlackRock supports a regulatory regime that increases transparency, protects investors, and facilitates responsible growth of capital markets while preserving consumer choice and assessing benefits versus implementation costs. We welcome the opportunity to address, and comment on, the issues raised by this consultation and we will continue to contribute to the thinking of the ESAs on any specific issues that may assist in improving the final outcome. Key points Performance scenarios As a default position we support the use of probabilistic modelling to show the probability of both upside and downside scenarios being realised. Presenting equally likely upside or downside scenarios may the easiest format for consumers to understand. However, as with the UCITS KIID the use of What if scenarios may be useful for structured funds and products based on a specific formula. [1] BlackRock is one of the world s leading asset management firms. We manage assets on behalf of institutional and individual clients worldwide, across equity, fixed income, liquidity, real estate, alternatives, and multi-asset strategies. Our client base includes pension plans, endowments, foundations, charities, official institutions, insurers and other financial institutions, as well as individuals around the world. 1

2 Costs Effectively supporting investors to make informed decisions We are supportive of increased transparency and helping investors improve their decisionmaking. It is important that consumers are able to weigh up the relative costs, performance and risk of individual PRIIPs. Each element should be given equal weight to assist investors when assessing the relative value of one PRIIPs over another. The process of delivering meaningful transaction costs data to investors will rely on the development of large sets of standardised trading history which allow the development of reliable and consistent models. This is likely to be an iterative process as the industry collectively develops consistent quantitative methods of providing this data. Consistency across regulations The issue of transaction cost reporting is now embedded in a number of other pieces of legislation (e.g. MiFID and PRIIPs). It is essential that the final reporting process adopted by the ESAs dovetails closely to that adopted for MiFID which in turn drives product cost disclosure for retail product disclosure in PRIIPS and which will lead to additional disclosure in both UCITS and AIFMD. Although the presentation may vary e.g. the provision of an aggregated figure under MiFID, it is essential that the figures are derived from the same building blocks in order to deliver consistency of approach thereby enabling meaningful comparability between providers. We also note that there are also a number of national initiatives such as the UK joint DWP/FCA work on disclosing costs to pension funds. We urge close cooperation between all regulators working on cost disclosure to agree a consistent methodology. Managing transaction costs within the context of performance We set out below a number of key considerations and potential pitfalls which should drive the analysis of how to report transaction costs. Inherent within this are our assumptions that: Transaction costs should be presented alongside performance It should be clear to clients that performance figures are after the deduction of transaction costs, not before, i.e. the management fee and other ongoing charges connected with running the scheme are costs that the client explicitly pays and components such as market impact are already reflected in reported performance via the executions achieved by the manager. Given the complexity of transaction cost analysis, and the various methods that can be used by different asset managers, unless a standardised process is used, there is a risk of clients being misled by a simple comparison of transaction costs: for example if one asset manager is more conservative in their estimates versus a competitor, the same objective cost may be reported quite differently. We therefore recommend: Reporting on the transaction costs in the context of the risk and return delivered by the portfolio. Provided they are presented in this context, portfolio turnover rates can provide a useful objective measure, and could be presented (as a percentage of the asset under management within the relevant portfolio) alongside transaction costs. Avoiding the "moral hazard" of differences in models, by ensuring that regulatory guidance is as specific as is reasonable and practical in what is reported to clients. Recommended approach to asset classes where elements of cost are explicit (e.g. equities and futures) For asset classes where elements of cost are explicit, such as equities and futures, BlackRock considers the most appropriate solution at present is to only reflect explicit costs, namely commissions and taxes, rather than using a total cost approach. This approach reflects the existing Dutch Pension Federation model of including only explicit costs for commission-based 2

3 products. This methodology provides transparency and objectivity in the client reporting and builds on existing Level 2 disclosure requirements currently in place. Recommended approach where to asset classes where elements of costs are implicit (e.g. fixed income and FX) Transaction costs are generally not explicit in fixed income transactions as these costs are embedded in the quoted price. Estimates of implicit commission costs for fixed income transactions may be based on a number of assumptions and measured in a number of ways. Different assumptions can significantly impact cost estimates, making meaningful comparisons difficult. The provision of client reports will inevitably have to be based on a number of assumptions since the vast majority of fixed income products are traded OTC on a principal basis. From the various options available, we recommend using the model used by the Dutch Pension Federation for fixed income as a basis and enhancing this framework by including additional asset classes. Market impact costs We do not recommend separate reporting on market impact costs as there is no agreed standard formula or benchmark. There is too much subjectivity in the calculation and too many qualitative interpretations required in order to properly interpret and understand how the choice of benchmarks and inclusion of various elements of cost impact the overall numbers reported to clients. As such it will not assist clients in assessing comparability of costs between managers or how market impact affects the portfolio s risk and return profile. In any case, as mentioned above, market impact is already reflected in reported performance figures and funds using anti-dilutive measures such as swing pricing the effect of market impact is being mitigated. Conclusion We appreciate the opportunity to address and comment on the issues raised by the Discussion Paper and will continue to work with the ESAs on any specific issues which may assist in risk, performance scenarios and cost disclosures in KIDs for Packaged Retail and Insurance-based Investment Products (PRIIPs) We would welcome any further discussion on any of the points that we have raised. Yours faithfully, Jonathan Cole Director, BlackRock Legal & Compliance jonathan.cole@blackrock.com Martin Parkes Director, BlackRock EMEA Public Policy martin.parkes@blackrock.com 3

4 Responses to questions 2. Risk and Rewards 2.2 Common issues for both the risk indicator and performance scenarios Question 1: Please state your preference on the general approach how a distribution of returns should be established for the risk indicator and performance scenarios purposes. Include your considerations and caveats. Our preferred approach for establishing a distribution of returns for both the risk indicator and performance scenarios is to use forward simulation rather than historical data. We agree with the comments in the Discussion Paper that while historical methods are easier to standardise and supervise, historical data does not inform the investor of future risks nor are indeed the most accurate reflection of the distribution of future returns. To be of most value to the end investor we believe that that risk indicator and performance scenarios chosen should be constructed to reflect information value to the investor. We agree that a modelling approach with predefined parameters is easiest to standardise and supervise though do not believe that it will necessarily be the most costly option to implement as it should be relatively straightforward for manufacturers to incorporate predefined parameters into the existing models they use. This approach will also have the benefit of more accurately reflecting the way manufacturers view risk in their products. Provided the parameters are predefined we do not believe this will detract from the comparability of PRIIPs from different manufacturers. We would not limit the type of the modelling used to stochastic modelling in order not to restrict the use of other types of modelling. Overall we would prefer a mixture of option d) and option e); i.e. Modelling chosen by the manufacturer based on parameters chosen by supervisory authorities Choice of model, choice of parameters Question 2: How should the regulatory technical standards define a model and the method of choosing the model parameters for the purposes of calculating a risk measure and determining performance under a variety of scenarios? What should be the criteria used to specify the model? Should the model be prescribed or left to the discretion of the manufacturer? What should be the criteria used to specify the parameters? Should the parameters be left to the discretion of the manufacturer, specified to be in accordance with historical or current market values or set by a supervisory authority? As noted above we are in favour of allowing the flexibility for the manufacturer to choose the model they consider most appropriate to the aim of providing clear, pre-transaction transparency for investors. This flexibility will allow firms to use models most appropriate to the characteristics of the products concerned. We feel this approach goes furthest in reducing the asymmetry in understanding between the manufacturer and the customer. We do however recommend that the rules to select the input variables in terms of risk variable, should be standardised and consistent across all models. Supervisory authorities should therefore prescribe the relevant input parameters. As indicated by the Discussion Paper, we would not recommend choosing a confidence level higher than 95% to avoid undue focus on tail risk Time value of money what represents a loss for the retail investor? 4

5 Question 3: Please state your view on what benchmark should be used and why. Are there specific products or underlying investments for which a specific growth rate would be more or less applicable? While the time value of money is an important investment concept, in the absence of a broadly applicable relevant rate, and the challenge of identifying rates that are free from significant and misleading bias, we consider option a), The amount invested without any adjustment to be the option most likely to create a fair and level playing field, and aid comparability across products. Pure reliance on an unadjusted growth rate could, however, be misleading over the longer term and, if a longer term holding period is recommended, the benchmark could be supplemented with narrative disclaimers noting the longer term effect of inflation. Question 4: What would be the most reasonable approach to specify the growth rates? Would any of these approaches not work for a specific type of product or underlying investment? We support the use of Option B. With respect to the specification of asset growth rates, we are in favour of using risk premiums prescribed by a central authority, based on historical returns of each asset class and asset type, to minimise competition effects. As the risk premiums may change over time, we agree that regular evaluation by supervisory authorities would be sensible Timeframe of the risk and reward information Reflection of time frame in the risk indicator Question 5: Please state your view on what time frame or frames should the Risk Indicator and Performance Scenarios be based As the KID includes a reference to a Recommended holding period, and an intended market to which the product is directed, we agree that it seems appropriate to build the risk indicator so that it reflects the recommended holding period stated by the manufacturer in the KID, including additional information or warnings about the limitations of the indicator (e.g. the risk level assigned is only accurate if the product is kept to the recommended holding period). Using the current UCITS KIID criteria, a time frame of 5 years would be an appropriate timeframe (i.e. normally 5 years). Consequently, a probabilistic or a possible outcome model on the basis of a maximum projection of 5 years would make sense. The data should be updated on a yearly basis. If a longer recommended holding period is chosen then we would favour including this as well. Accordingly, we are in favour of amending the wording of Option a), to show Show the risk indicator and performance scenarios for the recommended holding period and an intermediate period or periods if the recommended holding period is in excess of 5 years. Further time intervals could be included additionally at the manufacturers discretion. 2.3 Construction of a Risk Indicator Incorporating market risk into the Risk Indicator Credit risk Importance of credit risk High level description of possible credit risk measures 5

6 Question 6: Do you have any views on these considerations on the assessment of credit risk, and in particular regarding the use of credit ratings? When reviewing credit risk it is important to distinguish between the credit risk of the PRIIP and the credit risk of underlying investments of the PRIIPs which would typically subsumed into the consideration of market risk. Where the PRIIP is a product such as an insurance product or a bank sponsored balance-sheet product we agree that depending on the creditworthiness of the counterparty, credit risk is a key risk consumers should be aware of. In this case the credit risk of the PRIIP should be incorporated as a separate item in the indication of risk, rather than amalgamated with market risk, or preferably presented in separate narrative text. In terms of determining credit risk we recommend using average third party credit ratings rather than credit spreads. We agree that these quantitative credit risk measures may need to be complemented with additional qualitative measures of credit risk. For manufacturers or obligors for which credit ratings or the other mitigating factors are not available, then credit risk could be assessed on the basis of an analysis of credit ratings of comparable obligors. In addition, to enable meaningful comparisons between different types of PRIIPS, it is essential to enable off-balance sheet products, such as AIFs, to highlight that they provide no or little credit risk, as the investor is not exposed to either the product provider itself, or any other single obligor and that non cash assets are held in a separate ring-fenced account with the AIF s depositary and are protected from default by the manufacturer. 1 Liquidity risk Liquidity risk Question 7: Do you agree that liquidity issues should be reflected in the risk section, in addition to clarifications provided in other section of the KID? We agree that liquidity disclosures in the KID should distinguish between liquidity risk and the liquidity profile of a product. As liquidity risk is very challenging to quantify effectively, and changes vary according to market conditions, fund size, and investor profile, we do not believe that it should be displayed quantitatively in the risk section. Rather we recommend providing a qualitative narrative description. The liquidity risk of a product should be presented in the KID s risk section, not in the risk scale of the summary indicator, but as a narrative or warning below the indicator. Question 8: Do you consider that qualitative measures such as the ones proposed are appropriate or that they need to be supplemented with some quantitative measure to some extent? Should cost and exit penalties for early redemptions be considered a component of the liquidity risk and hence, be used to define a product as liquid or not for the KID purpose? BlackRock has written extensively on definitions of liquidity, most recently in a ViewPoint entitled Addressing Market Liquidity which provides useful analysis of how many asset managers assess liquidity risk 2. 1 Cash held by the AIF s depositary is still at risk where it is held as banker in which case, if the custodian bank became insolvent, the AIF would rank as an unsecured creditor. However as funds generally hold low cash balances in order to remain fully invested this is a fairly low risk

7 We do not believe it is possible to present an adequate quantitative indicator for liquidity, and recommend using a qualitative approach Translation of risk measures into risk indicators Translation of risk measures into risk indicators Option 1 Qualitatively based indicator combining credit and market risk, complemented by a quantitative market risk measure Question 9: Please state your views on the most appropriate criteria and risk levels definition in case this approach was selected. We believe that it will beneficial to break down the risks into market, credit and liquidity risk to ensure comparability between different PRIIPs. We do not believe that aggregating the measures would be beneficial or meaningful for investors. Market and product credit risk should be measured separately to allow consumers to see the different risks on their own (using different scales that may be shown separately) and should not be combined in an overall integrated risk classification. Liquidity risk should not be combined with the other risk measures to define the overall risk level, but should be explained in a narrative next to the indicator. Option 2 Indicator separating assessment of market risk - quantitative measure based on volatility - and credit risk - qualitative measure, external credit ratings Question 10: Please state your views on the required parameters and possible amendments to this indicator. We favour using Option 2 - Indicator separating assessment of market risk - quantitative measure based on volatility - and credit risk - qualitative measure, external credit ratings. We agree that market and credit risks should be assessed separately, and disclosed to produce a two dimensional risk indicator. Consumer testing will be needed to ensure that the combination of measures is readily understood by consumers. The viability of this option in legal terms (in relation to the level 1 text) should be clarified, as it is important for the investor that the indicator shows market and credit risk separately. Option 3 Indicator based on quantitative market and credit risk measures calculated using forward looking simulation models Question 11: Please state your views on the appropriate details to regulate this approach, should it be selected. No further comments as we favour use of Option 2. Question 12: Please state your views on the general principles of this approach, should it be selected. How would you like to see the risk measure and parameters, why? No further comments as we favour use of Option 2. Question 13: Please state your views on the potential use of a two-level indicator. What kind of differentiators should be set both for the first level and the second level of such an indicator? 7

8 No further comments as we favour use of Option Scale of the Risk Indicator Question 14: Do you have suggestions or concrete proposals on which risk scale to use and where or how the cut-off points should be determined? We believe the definition of the scale of the risk indicator should remain consistent with UCITS approach, which uses a scale of 1 7. Using a narrower scale would not allow sufficient differentiation between various types of products, e.g. between equity and multi-asset strategies. 2.4 Performance scenarios Question 15: Please express your views on the assessment described above and the relative relevance of the different criteria that may be considered. We would support the use of three scenarios: expected, upside and downside. Probabilistic modelling should be associated with each of the scenarios showing the probability of both upside and downside scenarios being realised. Presenting equally likely upside or downside scenarios may be the easiest format for consumers to understand. We believe that past performance scenarios with validated/confirmed numbers of how the product behaves under specific conditions remain the most reliable form of disclosure to the investor. As an exception to this general position there may be grounds for using a What if scenario in the case of certain structured products as is the case in the UCITS KID. For funds, the determination would have to be made at share class level. Rules similar to the UCITS KIID regulation should apply to new products having no past performance, or where there has been a material change in objective e.g. as a result of a merger. In this respect it would be helpful if the ESAs establish and develop a past performance model that can be relied upon across the board. We agree that presenting scenarios that are selected according to their probability helps consumers to assess which return can reasonably be expected and may provide a more realistic picture of products. These should, however, be accompanied by narratives explaining the information provided How to construct performance scenarios: methodological details to be prescribed in the regulation and input required Definition and number of scenarios What if: manufacturer choice Question 16: Do you think that these principles are sufficient to avoid the risks of manufacturers presenting a non-realistic performance picture of the product? Do you think that they should be reinforced? No further comments as we favour use of a probabilistic rather than a what-if approach. What- if: prescribed approach Question 17: Do you think the options presented would represent appropriate performance scenarios? What other standardized scenarios may be fixed? No further comments as we favour use of a probabilistic rather than a what-if approach. 8

9 Probability approach Question 18: Which percentiles do you think should be set? We support the three scenarios suggested: a pessimistic scenario as the 10th percentile of the distribution, a neutral scenario as the 50th percentile and an optimistic scenario as the 90th percentile. Combined approach Question 19: Do you have any views on possible combinations? We are not in favour of combined scenarios as we believe this will not facilitate understanding by the end investor Other methodological issues to calculate performance in each scenario Inclusion of credit risk events in the scenarios Question 20: Do you think that credit events should be considered in the performance scenarios? No we are not in favour of including credit events in performance scenarios. If this is a potentially significant risk to the investor this should be brought out in separate disclosure (e.g. issuer risk in respect of balance sheet product or the provider of the guarantee in the case of guaranteed products. Question 21: Do you think that such redemption events should be considered in the performance scenarios? No we are not in favour of including redemption events in standard performance scenarios. Investment horizon of the scenarios Question 22: Do you think that performance in the case of exit before the recommended holding period should be shown? Do you think that fair value should be the figure shown in the case of structured products, other bonds or AIFs? Do you see any other methodological issues in computing performance in several holding periods? The scenarios envisaged do not appear to be applicable to open-ended funds such as many retail AIFs which offer regular ongoing redemptions, or closed-ended retail funds such as UK investment trusts where investors typically dispose of their interests on the secondary market. 3 Costs Identifying the costs have we completed this work? Funds List of costs to be taken into account Question 23: Are the two types of entry costs listed here clear enough? Should the list be further detailed or completed (notably in the case of acquisition costs)? Should some of these costs included in the on-going charges? We recommend clarifying what "Acquisition costs" are being referred to in paragraph (b). Specifically, it is important to state in what scenario these costs arise and how these are incurred directly by the investor rather than the fund. We recommend making a clear distribution between up-front costs and acquisition costs as there may be incurred in different ways and may, in many cases, be incurred outside the control of the product manufacturer. We recommend clarifying whether the term acquisition costs is intended to cover costs of acquiring shares or units of funds on the secondary market e.g. closed-ended listed funds. The 9

10 acquisition costs for listed closed end fund products include entry and exit costs such as broker commissions, stamp duties and other charges (linked with wrapper products such as UK ISAs). These costs have different layers and basis and vary for different sets of investors. Some of the examples of up front initial costs (e.g. distribution fees, constitution costs and marketing costs) are typically considered operational in nature and incurred by the fund rather than the investors directly. As such they are more appropriate to include in the description of ongoing charges. We recommend including entry and exit costs as defined in CESR Guidelines on the UCITS KIID and so recommend including specific reference to exit costs such as redemption fees or switching fees that are deducted from redemption proceeds paid to the investors. We would also welcome clarification as to whether bid-offer pricing (e.g. dual-priced UK unit trusts) or swing pricing or other anti-dilution mechanisms e.g. the application of a dilution levy would constitute an entry/exit charge see further comments in our response to question 40 below. It is unclear how marketing costs would be allocated to individual investors. In many regimes marketing costs are borne by the manager out of their management fees and not as a separate line item. Where these marketing costs are charged to the fund, they would typically be charged to fund as an ongoing charge rather than allocated to individual investors. We would recommend deleting this reference or at least clarifying that marketing fees not charged directly to the investor are intended to be included under this heading. The text of the TDP also refers to separate treatment of fees across an umbrella to sub funds. It is worth noting that these fees will differ not only from sub fund to sub fund but also from share class to share class. This is recognised in the CESR Guidelines on the UCITS KIID see also our response to question 81 below. Question 24: How should the list be completed? Do you think this list should explicitly mention carried interest in the case of private equity funds? Generally we recommend compiling the list in terms of the type of service to which the cost relates. - i.e. (1) management instead of management company (2) corporate/fund governance instead of directors or partner (3) oversight and asset restitution rather than depositary etc. Investors may then be better able to attribute costs to services than to named individuals or institutions. The list should be shown to be indicative and not exhaustive. We would also include a residual category of any other providers providing services to the fund. We do not consider "Carried interest" to be an ongoing charge considering the conditional nature of such fee. We recommend that carried interest is treated in the section on performance fees. Question 25: Should these fees be further specified? We note that it may be useful to include an additional narrative disclosure indicating the relevant fee split between securities lending agent and fund. See further comments in respect of paragraph (r) below. In respect of real estate funds there are a number of variable costs which are incurred in respect of the acquisition or disposal of individual properties and as such are more akin to transaction costs and which should be treated as such. Otherwise this list provides the main examples of third parties to whom services are typically outsourced but given the different naming convention used between jurisdiction it should be made clear that the list is not exhaustive and focuses on the specific types of services provided. We would also include a residual category of any other providers providing services to the fund. It is also worth clarifying that fees included should be limited to those which are deducted from the fund. A distributor may use a sub-transfer agent when dealing with a fund and those costs will not be transparent to the product manufacturer but the distributor should be obliged to provide 10

11 these to the investors as part of the updated requirements under MiFID 2. There is therefore no need for them to be explicitly covered in the PRIIPs KID except by way of a narrative signpost that any MiFID regulated distributor, broker, or execution platform may charge additional fees which will be separately disclosed. Question 26: Should these fees be further specified? The recovering fees cover the following situation: when an investor receives income from foreign investments, the third-country government may heavily tax it. Investors may be entitled to reclaim the difference but they will still lose money in the recovering process (fee to be paid). In many cases these types of fees would already be included in the UCITS ongoing charges. If this methodology is followed then there is no need for these costs to be specifically called out otherwise there is the risk of double counting of costs. We assume that listing fees would also be included under paragraph (c). Question 27: Should these fees be further specified? The recovering fees cover the following situation: when an investor receives income from foreign investments, the third-country government may heavily tax it. Investors may be entitled to reclaim the difference but they will still lose money in the recovering process (fee to be paid). The wording is potentially ambiguous and appears to cover two potential situations here: The manager of the fund may seek to recover withholding taxes on behalf of the fund as a whole. In this case these costs would be included under paragraphs 9 (a), (b) or (f) and do not need to be separately accounted for. Claims made directly by investors, presumably the ultimate beneficial owner. This implies a tax reclaim procedure which the fund would not be involved with. As such the manager would have no control or even knowledge of individual investor circumstances. In many cases these types of recovering fees would already be included in the UCITS ongoing charges methodology. It is worth reflecting the fact that the cost of making these claims is more than offset by the income received by making these claims and should be seen as a net benefit. Accounting for these costs under paragraphs 9 (a), (b) or (f) also avoids the problem that there is also almost always a mismatch between the cost paid upfront and the benefit accruing much later, to a potentially different groups of investors. Typically the benefit is not accounted for until received whereas the cost is accounted for upfront. We therefore recommend deleting paragraph (d). Question 28: This list is taken from the CESR guidelines on cost disclosure for UCITS. What is missing in the case of retail AIFs (real estate funds, private equity funds)? In the case of private equity funds, would it be relevant to include a breakdown of flows, distinguishing those ( out ) paid by the fund for the proper functioning of its financial portfolio management from those ( in ) paid by the target company for the provision of advisory services. This breakdown would allow to clarify real costs for investors (instead of only indicating the net amount), knowing that in will be deducted from out ). In the case of costs of distribution, would this need to be detailed depending on the type of costs of distribution? To what extent are these costs different from the distribution fees mentioned in the Entry costs above? We agree with the inclusion of distribution costs where a specific charge is made to the fund. Otherwise where the management fee includes an element of commission which is paid away to distributors by way of retrocession, we believe it is up to the individual distributor to call out the amount of commission received to their individual clients in accordance with new MiFID 2 rules, rather than the manufacturer. 11

12 In certain jurisdictions, e.g. UK and Netherlands the manufacturer cannot pay for distribution as the costs of distribution have to be negotiated separately between end investor and their advisor. In this case there will be nothing to disclose by the manufacturer. In this case the end investor can only receive the total cost of investing from their advisor. It may be useful to include a narrative statement to this effect stating the investor s adviser can provide details of commissions received. Question 29: Which are the specific issues in relation to this type of costs? In respect of paragraph (h) there are a number of issues in including an ex ante statement of performance fees without providing an estimate. In particular we do not consider it appropriate to include performance-related fees within a specific on-going charge figure as these are contingent in nature. As such any such statement should be included separately in the breakdown of variable costs rather than fixed costs. In respect of paragraph (i) we note that interest on borrowings is not included in the equivalent UCITS requirements, though in the case of UCITS product regulation borrowings are limited in size and can only be made on a short term temporary basis. In this case the cost of borrowings is not material. We do however believe that for other PRIIPs there may well be the need to properly account for financing costs, or ensure that the statement of the investment return includes a set off for borrowing costs. As such we suggest that financing costs are excluded from the on-going charge figure as they are linked with the fund's investment activities and also difficult to quantify on an ex-ante basis. We would suggest that such costs are disclosed in a separate "Financing costs" category. Alternatively a separate summary indicator of the costs of leveraged returns through borrowings may be a useful metric for investors. Question 30: Is it relevant to include this type of costs in the costs to be disclosed in the on-going charges? Which are the specific issues in relation to this type of costs? Which definition of Costs for capital guarantee or capital protection would you suggest? (Contribution for deposit insurance or cost of external guarantor?) We support the inclusion of the costs of providing a capital guarantee to a PRIIP by the issuer or a third party guarantor. In the case of capital protection these are likely to be included in the statement of transaction costs. Where the capital guarantee is contingent on certain market conditions, it may be that only ex post disclosure of the actual costs will be meaningful. As a more general comment there is little detail on how the costs related to executing derivative strategies should be integrated into the costs methodology apart from the very generic statement in paragraph (l). At this stage we cannot say whether this would be sufficient to account for the costs of providing capital protection or whether a separate line item is required. Question 31: Which are the specific issues in relation to this type of costs? Should the scope of these costs be narrowed to administrative costs in connection with investments in derivative instruments? In that respect, it could be argued that margin calls itself should not be considered as costs. The possible rationale behind this reasoning would be that margin calls may result in missed revenues, since no return is realized on the cash amount that is deposited, and that: i) No actual amount is paid to a third party. Hence, one could argue whether these should be defined as costs of investing from a fundamental point of view. ii) It would be very challenging to quantify the actual missed revenue amount. Assumptions would be needed on the rate of return that would be realized on the deposited cash amount. Daily fluctuations in margin account balances will add to the complexity of required calculations. In respect of transaction costs referred to in paragraph (k), please see our more detailed comments on accounting for transaction charges in our response to questions below. We recommend that such costs are disclosed in a separate "Transaction costs" category. We do not consider it appropriate to include derivatives related costs within the specific on-going charges 12

13 figure as derivative costs as such are linked with the fund's investment activities. The only exception would potentially be for the administrative costs of holding derivative instruments. In respect of paragraph (l) we agree that margin calls in relation to derivative transactions should not be considered as a cost. Monies deposited in a margin account or assets which are pledged remain the property of a fund although held in a different account by a counterparty than the fund s normal custodian e.g. a CCP. Only if there is margin call will there be an actual loss, but even there this would normally be incurred to set off losses incurred by the fund. Question 32: Which are the specific issues in relation to this type of costs? Should this type of costs be further detailed/ defined? The issue of accounting for and payment for investment research received by the investment manager to the fund is still under discussion under MiFID. In particular it is still unclear how the proposed research payment account will operate and be accounted for. Currently in the case of the provision of portfolio management provided to a fund by a MiFID investment firm the amount of dealing commissions generated by the manager in respect of equity research should already be disclosed and included in the existing Level 2 disclosures of transaction costs to the fund s management company. Research in transaction based dealing costs should therefore already include the cost of research. As such these commissions do not need to accounted for under a separate line of costs. In the case of spread-based instruments there is not currently a clear way of allocating any inherent cost of research unless brokers start pricing fixed income research on a transaction cost base. Otherwise we would suggest that the cost of research for spread-based instruments is accounted for in the methodology proposed which recommends the use of a standard matrix. Going forward discussions as to how these accounts should be accounted for under the proposed research payment account (RPA) are still currently ongoing under MiFID. At this stage it is still unclear as to whether the RPA can be included in current transaction cost disclosure or as a separate line item. We would recommend delaying finalisation of this specific point until the position under MiFID is clearer. In particular, the need to set an ex ante budget may mean that this becomes a fixed cost rather than a variable transaction cost. Question 33: How to deal with the uncertainty if, how and when the dividend will be paid out to the investors? Do you agree that dividends can be measured ex-post and estimated ex-ante and that estimation of future dividends for main indices are normally available? Investment in UCITS and AIFs In respect of paragraph (n), there are a number of ways to interpret the concept of substantial proportion. It is possible to set a very specific threshold, such as 10% of the fund to establish a base-level understanding of substantial. The definition of a substantial holding may, however, vary if the fund invests in a number of funds with a very low cost base which overall do not have a material impact on the cost base. In this case the threshold could be higher. Alternatively if the fund invests in high alpha funds with a higher cost base the threshold should be lower. However, it may simpler to define a single methodology for all holdings of underlying funds so that there is one methodology for determining a synthetic TER. In this case we recommend giving consideration to excluding entry/exit charges for the underlying fund, and simply using the ongoing charges figure from the underlying fund. Not all AIFs in which a PRIIPs will invest will themselves be subject to PRIIPs so they may not present costs in a way which can be as easily assessed as is the case for retail AIFs or UCITS such as is the case for EU or non-eu AIFs which are only sold to professional investors. In this case some flexibility e.g. on a best efforts basis efforts is required to determine the fund s total cost. Even in the case of retail AIFs, an element of the costs will include estimated ex-ante figures. We assume that the investing fund can take the updated figures from the PRIIPs provider or UCITS 13

14 without having to conduct further verification of estimated costs against the updated historic figures in the published accounts. Securities Lending Securities lending is a long established practice in global financial markets that provides liquidity to markets while also generating additional returns to investors who lend securities 3. The availability of securities through lending arrangements is widely viewed as providing liquidity to the markets. 4 Securities lending involves a loan of securities to a third party, the borrower, who gives the lender collateral in the form of cash, shares or bonds in an amount equal to the value of the loaned securities plus an additional margin above that amount 5. The total income from the transaction is continuously divided between the lender and the lending agent according to the previously negotiated fee split. The lending agent s portion represents its compensation for arranging the loan. The lender receives at a minimum the same economic exposure to a security on loan, including any dividends or distributions, as if the loan had not occurred, although the lender must recall shares in order to vote proxies. Securities Lending Fee Information BlackRock believes that a well-designed securities lending programme, including robust assessment of borrowers, independent risk management, strict collateral standards and prudent collateral management, can add significant value to clients investment results. 6 Investor protection is well served by a level playing field that allows investors to make informed choices on a risk adjusted basis balancing fees charged alongside performance and risk management capabilities. Moreover, investors and fund boards and management companies will particularly benefit from information on administrative fees and indemnification fees. We believe that in order to fully understand the securities lending fees, an investor, regulator, or a fund board should not have a singular view on the fee split percentage. Specifically, while the fee information would provide an explicit source of comparable information about contractual arrangements, it does not provide any meaningful information about performance (e.g., gross lending income), which would be necessary in order to enable the public, regulators and fund boards to draw necessary conclusions regarding lending agent capabilities and results. Thus, we recommend that funds engaged in securities lending also be required to report aggregate securities lending income earned during the reporting period (gross and net to the fund) and any costs or expenses allocated to the fund in connection with securities lending, including any administrative fees and indemnification fees. In order to provide a holistic view of securities lending activities, information about the percentage of a portfolio which is lent should also be disclosed. BlackRock has updated its fund documentation in recent years to provide this level of information. In this way investors can clearly identify securities lending earnings that go to the fund, to the lending agent and third parties. Requiring only affiliated lenders (the PRIIP manufacturers) to report these costs would not create a level playing field as this would make PRIIPs that outsource securities lending look artificially cheaper. Consequently, in terms of the type of disclosure in paragraph (r) investors would be better informed if they were told (1) whether the fund may engage in securities lending and (2) of the securities lending fee arrangement in the KID document. Since securities lending income 3 See, e.g., Dreff, Nadja, The Role of Securities Lending in Market Liquidity, Financial System Review Bank of Canada (June 2010); Dive, Matthew, Developments in the Global Securities Lending Market, Quarterly Bulletin, Bank of England (3rd Quarter 2011). 4 In May, 2012, BlackRock published a ViewPoint entitled Securities Lending: Balancing Risks and Rewards. In this publication, we explained the benefits of securities lending to markets and to investors while also highlighting the risks associated with this investment practice and offered several recommendations for the enhanced regulation of securities lending. This publication is available at < pdf>. 5 BlackRock typically requires borrowers to post collateral between 102% and 112% of the value of the securities lent. 6 BlackRock, ViewPoint, Securities Lending: The Facts (May 2015), available at pdf ( Securities Lending May 2015 ViewPoint ) 14

15 fluctuates over time a fund s annual financial report, a retrospective document that is audited, is in our view better suited for the disclosure of securities lending costs in monetary terms. If ex ante estimate is required we strongly recommend the use of a narrative warning that the figure reported is purely an estimate based on historic reported figures and that actual costs will vary, as for all variable fees. Dividends In respect of paragraph (t) for funds, dividends from underlying investments are received by the fund into its income account. The accumulated income from underlying dividend or interest payments (in the case of fixed income instruments) is then paid out to investors on specific predefined dates e.g. annually, six-monthly, quarterly) or rolled up into the fund s capital account thereby increasing the fund s NAV. Given the divergence over time between the funds, in UCITS, shares classes which distribute income or roll up or accumulate income generally have a separate KIID to show the differential in accrued performance. Some funds will have income smoothing arrangements whereby income is held back to ensure a regular payment or the funds may draw on capital reserves to meet a set income payment whereas other funds will pay a variable income. In each case this a key feature of the fund and should be included in the section setting out the structure of the fund. In addition appropriate narrative risks and disclosures should be given in respect of the relative benefits of each type of income distribution arrangement. There are also many cases where the fund is not the beneficial owner of the underlying securities. For example in derivative transactions, the fund receives the underlying corporate actions on the underlying basket of shares from the counterparty or the return on the structured note is adjusted for corporate actions with an adjusted return received from/ paid to the counterparty. In this case the receipt or non-receipt of dividends is an implicit or opportunity cost which forms part of the net return on holding such instruments rather than an additional cost incurred by the investor Specific issues related to certain types of costs Question 34: Is this description comprehensive? We note and support the comments from both EFAMA and the UK Investment Association in this respect. We agree that this is a comprehensive description. As a general point to avoid confusion with custody transaction costs which are covered by paragraph (a) under on page 54 of TDP it would be helpful to refer to market transaction costs. Our key recommendation is to present variable transaction costs separately from fixed management and administration costs. Transaction costs are variable in nature and reflect the investment and risk strategies a manager uses to deliver the fund s investment objective and react to unpredictable market events. We set out below a number of key considerations and potential pitfalls which should drive the analysis of how to report transaction costs. Inherent within this are our assumptions that: Transaction costs should be presented separately from other charges and expenses and clearly linked to performance. A distinction should be drawn between fixed and variable elements re ex ante disclosures and explicit costs should be distinguished from implicit costs. There should be consistent definition and disclosure of the assumptions used to make ex ante disclosures to avoid inconsistencies and, worse, manipulation. It should be clear to investors that performance figures are delivered after the deduction of transaction costs, not before. This means that the management fee and other ongoing charges connected with running the fund are costs that the client explicitly pays and components such as market impact are already reflected in reported performance via the executions achieved by the manager. Contingent costs should be separately categorised with disclosures setting out the conditions which trigger the crystallisation of the fee. 15

16 Given the complexity of transaction cost analysis, and the various methods that can be used by different asset managers, unless a standardised process is used, there is a risk of clients being misled by a simple comparison of transaction costs: for example if one asset manager is more conservative in their estimates versus a competitor, the same objective cost may be reported quite differently. We therefore recommend: Reporting on the transaction costs in the context of the risk and return delivered by the portfolio. Provided they are presented in this context, portfolio turnover rates can provide a useful objective measure, and could be presented (as a percentage of the asset under management within the relevant portfolio) alongside transaction costs. Avoiding the "moral hazard" of differences in models, by ensuring that regulatory guidance is as specific as is reasonable and practical in what is reported to clients. Question 35: Can you identify any difficulties with calculating and presenting explicit broker commissions? How can explicit broker commissions best be calculated ex-ante? On an ex-post basis we do not foresee any difficulty. From an ex-ante perspective commissions which compensate for the service of agency execution tend to be standardised and fixed by instrument or market and method of execution and therefore do not present a significant challenge. However, it should be noted that commissions paid for the service of principal execution can and do vary based on order characteristics and thereby cannot be calculated with the same accuracy on an ex-ante basis. We recommend the use of estimates based on historical data. As noted in our response to question 32, dealing commission or the payment for research may need to be broken out, especially if the final MiFID Level 2 text requires managers to use a separate RPA. For asset classes where elements of cost are explicit, such as equities and futures, we consider the most appropriate solution at present is to only reflect explicit costs, namely commissions and taxes, rather than using a total cost approach. This approach closely reflects the existing Dutch Pension Federation model of including only explicit costs for commission-based products. This methodology provides transparency and objectivity in the client reporting and builds on Level 2 disclosure requirements currently in place. It does fall short of representing all possible costs inherent with trading and investing though, as mentioned above other implicit costs are reflected in reported performance so their effect is not, as such, hidden from the investor. This again reinforces the usefulness of showing past performance figures alongside the predicted performance presentations required under PRIIPs. Questions 36: How can the total of costs related to transaction taxes best be calculated? How should this be done to give the best estimate ex-ante? Are there other explicit costs relating to transactions that should be identified? Do you think that ticket fees (booking fees paid to custody banks that are billed separately from the annual custodian fee paid for depositing the securities) should be added to this list? We concur with comments from the UK Investment Association that the best approach to calculating transaction taxes (such as stamp duty and FTT) on an ex-ante basis is by showing a weighted average of the transaction tax rates applicable in each country in which the portfolio is invested at the end of the financial year. An alternative approach might be to use the actual rates apparent from transaction taxes paid, but geographical shifts in the portfolio over the year make this approach less likely to represent the future shape of the portfolio. 16

17 It also important to note that transaction taxes do not apply to all flows for example they may apply to purchases and not sales. Transaction taxes also have different layers and bases and vary for different types of instruments. So for example a UK equity fund (where stamp duty is charged on purchases) receiving high levels of subscriptions will incur significant level of transaction costs whereas a competitor fund with high levels of redemptions will not incur these taxes. It may be that there should be a narrative disclosure that certain strategies will necessarily incur greater costs due to transactions taxes which apply to the underlying market. We believe that ticket fees should already be captured within the scope of paragraph (a) on page 54 of the TDP and such would not need to be separately disclosed. Broker commissions included in the spread of bonds Question 37: As regards the abovementioned estimate, can the fair value approach be used? We are unclear as to how the fair value approach could be used to estimate the commissionequivalent element in the spread. A fair value approach could become ambiguous and there could be varying practices relating to the estimates of broker commissions incurred in the spread of the transactions. As mentioned in our response to Question 38 we prefer the approach of standard matrix for non-equity transactions which would provide greater consistency and reduce the administrative burden on implementation. Broker commissions included in other financial instruments Question 38: Can you identify any other difficulties with calculating and presenting the bid-ask spread? Do you believe broker commissions included in the spread should be disclosed? If so, which of the above mentioned approaches do you think would be more suitable for ex-ante calculations or are there alternative methods not explored above? In answering this question we recognise that the capturing and reporting of bid-ask spreads for the purposes of cost measurement could take 3 or more forms, namely: An institution requests, receives and stores a 2-way market on each and every quote request An institution captures and stores a real-time composite of firm or indicative bid-ask spreads from a data vendor or trading platform An institution captures and stores some static indicative bid-ask spreads via a periodic survey of market participants for some pre-defined size The first proposal is the most comprehensive and would lead to the most accurate representation of the cost of trading. Calling for a 2-way market on each quote request is, however currently uncommon in some asset classes and would be require a significant change of practice. The second proposal is in theory achievable for many instruments but would require significant technical investment from most firms and would not achieve the same level of accuracy as the first proposal as it would be independent of size of order. Then, recognising that the third proposal is the least accurate, it is the most easily achievable and is in fact existing practice for some firms and is most closely akin to the Dutch Pension Federation model mentioned in the TDP. We note that the approach adopted by the Dutch Pension Federation model for fixed income cost disclosure includes: (a) a transaction-cost "grid" showing spreads by asset class for a limited number of asset classes, and (b) detailed formulae e.g. that cost is equal to half of the bid-ask spread. Our own internal transaction cost models use a similar methodology, although using a more detailed "grid" than the simple 5x1 matrix as shown in the Dutch model on page 62 of the TDP. 17

18 We believe that this model could be developed further with a more detailed grid using more instrument types, thereby improving the accuracy of the overall model. A potential issue with the Dutch model is that different product manufacturers could use materially different grids of bid-ask spread, and product manufacturers may not agree that half the bidask spread is the right measure. These issues could be addressed by industry participants agreeing an industry standard bid-ask spread, in order to avoid the moral hazard that would be generated if different models were employed by different product manufactures and regulatory specification of the different base formulae to be used. We also note that in respect of derivatives the costs of employing derivatives are no simpler than what we have described above and in some circumstances are more difficult. Listed derivatives will tend to attract explicit commissions and often have reliable and stable spreads, some OTC derivatives will have reliable and stable spreads, others will not and there is unlikely to be much, if any, measurement of market impact in any OTC derivative products. Question 39: Do you believe that market impact costs should be part of the costs presented under the PRIIPs regulation? If so, how can the market impact costs best be calculated? How should this be done to give the best estimate ex-ante? A potential advantage of capturing and reporting market impact is that it will enhance an investor s understanding of the total cost of investing, for example, an investor who was considering investing in a large cap-focused product versus a small cap-focused fund would be able to see that the former, on average, incurred less costs through market impact. The investor would then be considering whether the diversification benefits and potential for additional risk premium outweighed the higher costs and liquidity they would bear with the small cap-focused investment. The disadvantage is that market impact costs can be highly volatile especially where trades are executed over long horizons. In these situations, it can be difficult to separate out the cost of demanding liquidity from the consequences of execution timing. Additionally, the evaluation of market impact only becomes more reliable when there are an ample number of transactions to measure. Portfolios which trade infrequently or have a high degree of concentration in orders will not have sufficient data to properly assess market impact, they only become statistically reliable when one builds up a large enough data set and the majority of traditional active portfolios with concentrated positions risk fail to have sufficient data to be useful. Estimation models could be used to provide more consistent and stable measures of total cost. Most models are, however, calibrated against transaction data which is uniquely available to the model builder. This means the estimates will not be consistent among different providers or transaction cost models because the underlying data is not identical. Model estimates will also be susceptible to sampling bias if there isn t sufficient representation of a particular population within the transaction data. For instance, models may be less reliable for predicting costs of large orders if the data used to build the model primarily consists of small orders. Overall market impact is a function of the liquidity available in the market, volatility, and the size of the order. As the abundance or lack of liquidity on any given day (or level of volatility) is out of the control of the investment manager, the impact of availability of liquidity is more closely related to market risk than cost. Costs calculations therefore should be limited to observed implicit cost such as spreads, commissions, and taxes. As such we do not believe that it is practical to develop a standardised comparable model for market impact costs for asset classes such as equity and futures. Implicit in the analysis is a question as to whether the manager is meeting its duty to obtain best execution which contains a number of qualitative criteria which are not capable of being reduced to a single numerical value. 18

19 Question 40: How should entry- and exit charges be calculated considering the different ways of charging these charges? How should this be done to give the best estimate ex-ante? Can you identify any other problems related to calculating and presenting entry- and exit fees? When investing in underlying funds it is not possible to predict what the impact of entry/exit charges for example under a dual priced or single priced mode with a dilution levy or swing pricing as these depend on the flows of into our out of the fund on a specific day. This potentially means making an assumption that there will be no flows in the underlying funds which will affect the investing fund and therefore no ex ante disclosure. While we can offer historical data on the benefits to remaining holders of the exercise of anti-dilution measures, we believe these are better presented in terms on improved performance rather than as a cost. For example in 2011, BlackRock conducted a study on the benefits of swing pricing on a number of its fund strategies 7. RESULTS OF 2011 STUDY ON SWING PRICING FOR REPRESENTATIVE FUND STRATEGIES Fund Name No, of Swings During Period Beginning Price in Base Currency Price on 6/30/11 in Base Currency Class Base Performance Performance Without Swinging Perform ance Benefit Asian Bond % 4.59% 2.52% Global High Yield % 12.11% 2.13% USD High Yield % 14.25% 0.69% Specialists Global % 27.89% 0.45% Equity Emerging Markets % 9.97% 0.41% Bond Country Specific % 12.95% 0.40% Asian Equity Emerging Markets % 30.48% 2.24% Small Cap Equity Unconstrained Fixed % 2.06% 0.49% Income European Equity % 9.95% 0.44% Absolute Return European Equity % 18.62% 0.41% 130/30 European Credit % -4.73% 0.38% As can be seen these various anti-dilutive measures are designed to protect the underlying funds existing investors from the dilutive effects of other investors entering or exiting the fund. Therefore the costs to an investor would have to be balanced out by an offset to account for the benefit of other investors in the underlying funds paying entry and exit charges. This could allow the manager to take the view that their swing pricing methodology is effective and therefore that on days a fund applies swung price that there are no effective market transaction costs as they will be offset by the effect of swing. This also avoids splitting out the element of transaction costs covered on a given day against the trades conducted for investment or rebalancing purposes. We also recommend that the effect of entry / exit charges used in anti-dilution mechanisms are more appropriately disclosed ex post. Ex ante disclosure would best be made by plotting percentage rates (swing for example) against flow size graphically or in a table. Where there is a variable element to the swing rate this should be made clear by distinguishing these types of cost and providing appropriate disclosure. 7 Source: BlackRock, August and November

20 Finally, we would instead recommend focussing on the disclosure of portfolio turnover rate as a better indication of the overall costs incurred by the fund. Question 41: Which other technical specifications would you suggest adding to the above mentioned methodology? Which other technical issues do you identify as regards the implementation of the methodology? We support the use of a hybrid model for reporting costs as this would allow a mixture of known costs such as explicit transaction based costs and implicit costs, the impact of which can be modelled using the type of table recommended in our answer to Question 38. However, there may need to be some flexibility for certain categories of funds such as private equity and funds in the alternatives space where actual cost models may be needed. In respect of the detailed calculation of the methodology we recommend that regular cash sweeps and purchase/sale of investments "in specie" (i.e. asset not traded in the market) should be excluded from the purchases/sales figure. It would also be helpful to clarify that implicit costs such as spreads are excluded from the methodology. In the description of the use of standardised costs the TDP raises concerns that a standardised model reduces incentives to control costs. We note that the key purpose of the KID is to enhance comparability between different product types not as a tool to manage costs levels. This a composite exercise allowing the investor to assess the relative value of competing products across all dimensions of relative cost, performance and risk. The PRIIPs KID is designed to bring out each of these three elements. So while transparent cost disclosure is an essential foundation, it is also critical that the investor can assess the impact of costs in the context of relative return and performance. Higher transaction costs can be justified if they result in greater performance or improved risk management. Simply focusing on cost as a sole metric could be potentially misleading. Fund managers are subject to best execution requirements e.g in MiFID and AIFMD, which involves an assessment in which cost is a significant, but not the only, criterion. In this context portfolio turnover rates are a useful data point provided they sit alongside reporting on risk and return. In this respect, we recommend the UK Investment Association s work on reporting portfolio turnover rates. We believe this could form the basis if an industry agreed calculation of turnover to be shown alongside transactions costs and fund performance. Question 42: Do you think that an explicit definition of performance fees should be included? Do you think the definition by IOSCO is relevant in the specific context of the cost disclosure of the PRIIPs Regulation? Given the variety of performance fee models used and the lack of a standardised European definition we support the use of an explicit generic statement such as a variable fee linked to the performance of a fund. The definition by IOSCO is relevant in the context of this disclosure to ensure a consistent approach. Question 43: What would be the appropriate assumption for the rate of returns, in general and in the specific case of the calculation of performance fees? Given the lack of uniformity in the calculation of performance fees, the key outcome for investors is to show an example of how the performance fee works, when triggered. For consistency it would be ideal if the scenario shows the performance fee working in the context of an optimistic rate of return, assuming that a well-designed performance fee would not pay out in the case of a neutral or pessimistic scenario. If a standard mandated optimistic return does not in fact trigger payment of the performance fee then potentially a higher rate which does show the operation of the performance fee would be needed. This could then be supplemented with another scenario showing a conversely low probability of the performance fee paying out. 20