PRIIPS Last Challenges. UNDERSTANDING THE IMPACTS OF THE PRIIPS RTS By Mario MANTRISI

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3 REGULATORY BACKGROUND Art. 10 Art. 11 CHAPTER II Art. 12 Where a PRIIP offers different underlying investment options PRIIP manufacturers shall produce one of the following: a) A key information document for each underlying investment option within the PRIIP, including information about the PRIIP overall ; b) A generic key information document describing the overall PRIIP unless otherwise specified in Articles 11 to 14. In the section entitled What is the product specify the following: a) Description of the types of options including market segments or instrument types b) that the type of investors to whom the PRIIP is intended varies on the basis of the underlying investment option c) where the specific information on each underlying investment option is to be found In the section entitled What are the risks and what could I get in return specify the following: a) Range of risk classes of all options using a summary risk indicator having a numerical scale from 1 to 7; b) that the risk and return varies on the basis of the underlying investment options; c) how the performance as whole depends on the underlying investment options TWO APPROACHES CONTENT OF THE GENERIC KID Art. 13 In the section entitled What are the costs specify the following: a) Range of costs in the Costs over time and Composition of costs tables; b) that the costs vary on the basis of the underlying investment options Art. 14 manufacturers shall include for each underlying investment option all the following: a) A comprehension alert, where relevant b) The investment objectives, means for achieving them and the intended target market c) A summary risk indicator and narrative, and performance scenarios d) A presentation of the costs... INFO ON INV. OPTIONS 6 October KNEIP All rights reserved 3

4 2 APPROACHES FOR THE PRIIPS MANUFACTURER HYBRID KID BOOKLET SEPARATED BOOKLET Produce a KID for each investment option offered, combining details of the options with information on the product as a whole («1 KID per option») Produce a single Generic KID for the insurance product as a whole, outlining generic information on the options, with details of the investment options provided separately. GENERIC Option 1 Option 2 Option... Option n + SRI + narratives Perf. Scenario Costs SRI + narratives Perf. Scenario Costs SRI + narratives Perf. Scenario Costs SRI + narratives Perf. Scenario Costs LIGHT Option 1 LIGHT Option 2 LIGHT Option... LIGHT Option n Investment Option 1 manufacturer Investment Option 2 manufacturer Investment Option.. manufacturer Investment Option n manufacturer Product information Investmt. objectives Perf. Scenario SRI, Costs Product information Investmt. objectives Perf. Scenario SRI, Costs Product information Investmt. objectives Perf. Scenario SRI, Costs Product information Investmt. objectives Perf. Scenario SRI, Costs Combine features of the insurance contract with the features of the investment options in one document for each investment option including: Investment Objective Targeted retail investor Risk indicator/narrative Performance scenario Costs Investment Option 1 manufacturer Investment Option 2 manufacturer Investment Option.. manufacturer Investment Option n manufacturer Specific content to be included in the generic KID, specifically on: «What is this product?» section Risk indicator/narrative Performance scenario Costs 6 October, KNEIP All rights reserved 4

5 PROFILE APPROACH on DISCRETIONARY MANDATES Discretionary Portfolio Managers should consider an investment option as being an investment profile. Therefore these managers have to provide information related to the mandates using the following profile approach : - The information to be provided by Asset Managers (DPM) to insurance companies must be at the level of the mandate itself, not at the level of the underlying assets of the mandate PROFILE-LEVEL KIDs Produce a KID for each mandate or investment profile, («1 KID per option») Investment profile 1 Investment profile 2 Investment profile... PRIIPs manufacturer (Insurance company) Investment profile n!!! - Calculations of Risk and Performance scenarios to be done using the investment profile (model portfolio, or model asset allocation, or benchmark). Example: SRI + narratives Perf. Scenario Costs Investment mandate 1.1 SRI + narratives Perf. Scenario Costs Investment mandate 1.2 SRI + narratives Perf. Scenario Costs Investment mandate 2.1 SRI + narratives Perf. Scenario Costs Investment mandate n.1 - Aggressive Investment profile with model asset allocation = 80% equities / 20% bonds à calculations of MRM using appropriate benchmarks modelling this particular asset allocation. Absence of data or poor-quality data from Discretionary Asset Managers will lead to the following: - Insurance companies will apply their own Investment profiles implemented based on the monitoring of investment limits currently applicable.! Asset Manager 1 Asset Manager 2 Asset Manager n Combine features of the insurance contract with the features of the mandate (or investment profile) in one document including: Investment Objective Intended target market Risk indicator/narrative Performance scenario Costs - These profiles defined by the insurance companies will therefore have to be respected by the Asset Managers. 6 October, KNEIP All rights reserved 5

8 PRIIPS CATEGORY IDENTIFICATION FOR MRM CATEGORY GENERIC PRINCIPLES 1 IF PRIIP is a derivative as per MIFID II definition OR Potential loss > Amount invested OR PRIIP or its underlying assets: - have prices with frequency less than monthly - do not have appropriate benchmark/proxy - Have appropriate benchmark/proxy with prices less frequent than monthly 2 IF PRIIP has nonleveraged exposure to underlying assets prices OR Leveraged exposure on underlying asset(s) that pays a constant multiple of underlying assets prices AND >= 2 YRS of historical daily prices for the PRIIP OR >= 4 YRS of historical weekly prices for the PRIIP OR >= 5 YRS of historical monthly prices for the PRIIP OR A natural benchmark/proxy exists with same frequency if historical data not available. 3 IF Exposure on underlying asset(s) that pays a NON-constant multiple of underlying assets prices AND >= 2 YRS of historical daily prices for the underlyings OR >= 4 YRS of historical weekly prices for the underlyings OR >= 5 YRS of historical monthly prices for the underlyings OR A natural benchmark/proxy exists with same frequency if historical data not available 4 IF PRIIPs whose value depends in part on factors not observed in the market. 6 October KNEIP All rights reserved 8

9 MARKET RISK MEASURE (MRM) Qualitative classification of products into one category (1 to 4). Example categorization could be: Category 1: Funds with valuation on a less-than-monthly basis (RE/PE) ; derivatives Category 2: Non-structured funds ; pure unit-linked insurance products with no profit sharing, UCITS,AIF Category 3: Certificates ; Structured products; Structured funds Category 4: With-profits insurance products Application of a calculation methodology according to categorization: Category 1: Direct assignment of MRM Derivatives à MRM = 7 ; Other products à MRM = 6 Category 2: Cornish Fisher expansion based on VaR Category 3: Bootstrapping methodology (10,000 simulations to be performed) Category 4: Mix between bootstrapping and market standard model Scale of MRM vs. VaR-equivalent- volatility significantly changed compared to last version of the RTS Resulting MRM and SRI for PRIIPS will be lower than the current SRRI in 90% of the cases 5 years history of prices (or benchmark if history not available) to be used as basis for calculation 6 October KNEIP All rights reserved 9

10 CREDIT RISK MEASURE If the PRIIP is a fund fully compliant with UCITS V or AIFMD and fully collateralized à CRM = 1 no look through If the PRIIP is an insurance product and is held and identified on accounts in compliancewithnationallaws andwith SolvencyIIà CRM = 2 no look through No need to assess CRM for a product with MRM = 7, as the SRI will be 7 anyway If the PRIIP is exposed to other underlyings the CRM shall be assessed for both the PRIIP itself (except UCITS & AIF) and the underlyings on a look-through basis and cascade assessment If the PRIIP is exposed to multiple underlyings, CRM must be assessed separately only for each underlying representing an exposure of at least 10% of the total assets/value of the PRIIP. Exposure to ETDs, cleared OTC derivatives and fully and appropriately collateralised exposures shallbe assumed to carry no Credit Risk. CRM to be adjusted based on the life time of the product 6 October KNEIP All rights reserved 10

12 PERFORMANCE SCENARIOS Computation of performance scenarios linked to the categories used to calculate MRM Use of probabilistic methodology for selection of favorable, moderate and unfavorable scenario (90th, 50th, 10th percentile of calculated returns) Historical prices used as basis to compute future performance scenarios identical to the ones used for Market Risk Potential possibility that RHP does not need to be aligned in case of MOP ( referring to the Non Paper of the EC) Performance scenarios to be presented net of costs Payoff graph to be shown for Exchange-Traded Derivatives instead of tables Number of interim periods dependent on the Recommended Holding Period (the RHP if less than 1Y ; two if RHP between 1Y and 3Y ; three if RHP more than 3Y) For insurance products, discretionary profit participation can only be used in the favorable scenario Must be presented both in monetary units and in percentages as average annual return Death scenario to be presented as a 4th scenario only in monetary figures for regular-premium insurance products ( biometric risk) 6 October KNEIP All rights reserved 12

Single premium product? RHP more than 3 year?

13 PERFORMANCE SCENARIO SELECTION Echange- Traded Derivative? No Insurance product? No RHP more than a year? No 1 period and 3 scenarios à 3 scenarios Yes Yes One scenario Pay-off graph RHP typically longer than 3 years Yes Single premium product? RHP more than 3 year? No 2 periods and 3 scenarios à 6 scenarios 3 periods and 3 «survival» scenarios + 1 «death» scenario à 12 scenarios 3 periods and 3 scenarios à 9 scenarios 6 October KNEIP All rights reserved 13

15 LIST OF COST IN SCOPE FOR PRIIPs Costs categories in the KID Asset Managers Banks Insurance companies One-off costs Entry costs Exit costs - Distribution fees (maximum allowed) - Constitution costs - Marketing costs - Subscription fees including taxes - Sales commissions - Structuring costs - Hedging costs - Legal fees - Capital guarantee costs - Implicit premium paid to issuer - Proportional fees - bid-mid spread (for early exit) - Structuring costs - Acquisition, distribution costs - Processing costs - Cost of holding required capital - Cost part of the biometric risk premium Portfolio transaction costs p.a. - Portfolio transaction costs - Portfolio transaction costs - Portfolio transactions costs Insurance costs - N/A - N/A - Cost part of the biometric risk premium or full biometric risk premium Ongoing costs Other ongoing costs p.a. - Management fees - Depositary fees - Directors fees - Advisory fees - Administration fees (FA, TA, prime broker) - Securities lending fees - Regulatory, registration, listing fees - Audit fees - Legal, professional fees - Marketing and distribution fees (maximum allowed) - Financing costs - Implicit costs for structured funds - Other costs - Costs related to the underlying - Coupon payments costs - Structuring, marketing costs - Acquisition, distribution costs - Processing costs - Administrative costs - Cost of holding required capital - Depositary fees Incidental costs Performance fees - Performance-related fees - N/A - N/A Carried interests - Carried interests - Carried interests - Carried interests 6 October KNEIP All rights reserved 15

16 COSTS Entry costs now include subscription fees including taxes if country specific taxes included, this could mean to having a different number per country Maximum distribution fees allowed if not known by management companies Methodology for computation of actual transaction costs à difference between arrival price and net realized price Arrival price corresponds to the mid-market price at the time the order is transmitted à where and how to retrieve the mid-market prices? What if the result is negative? To be computed based on a history of the last three years In the absence of mid-marker price, opening or closing prices may be considered, but what to do in case of high volatility? For products existing for less than 3 years, a different methodology to compute transaction costs should be used: estimated PTR to be extrapolated against a benchmark to be selected based on asset classes Insurance costs to be disclosed as a separate line in the composition of costs table (biometric risk) Could lead to individualized documents based on the age of the policyholders Computation of the Reduction-in-Yield (RIY) based on the moderate scenario and the respective cost-free scenario. (Cost over time) ETDs to take a performance of 3% into account when calculating the RIY Exit fees not included on cost composition table, however must be present in Cost over time and described in How long should I hold it 6 October KNEIP All rights reserved 16

18 Comprehension Alert and KID Revision/Monitoring/Publication Comprehension Alert most likely to follow UCITS eligibility rules ( following Non Paper of the EC) KID s need to be revised yearly based on last publication date KID s need to be updated in case of material change. Currently guidance is given for risk ( MRM calculation depending on the valuation frequency and monitoring based on a 4 months sliding period) Performance needs to be monitored and updated in case of 5 % deviation All other changes are left to the appreciation of the manufacturer Updated KID s must be available on the website No need to inform existing investors on updated KID s ( confirmed during the workshop of the EC in July 2016) Insurance PRIIP s KID need to notified to the FSMA ( in principal by the advisor/distributor of the product Art 74 of the Law of ) Responsibility of the Distributor to remit the KID within PRIIPS. Distribution oversight and Product governance responsibilities for the manufacturer and distributor to be looked within MIFID II / IDD 6 October KNEIP All rights reserved 18

20 FLEXIBLE FUND CATEGORIZATION A flexible fund is a fund with a are managed according to investment policies and/or strategies that pursue certain reward objectives by participating through flexible investment in different financial asset classes according to point 14 of Annex 2 of the RTS. Such funds are to be classified under Category 2. Different computations to be done on VaR-equivalent-volatility required, using the maximum of the: VeV calculated using the standard CF VaR expansion, VeV calculated based on the pro-forma asset mix VeV calculated based on the risk limit (or volatility budget ) of the fund 6 October, KNEIP All rights reserved 20

22 European PRIIPs Template (EPT & CEPT) EPT Comfort (CEPT) Minimum Prices (or benchmarks for DPM) Narratives RHPs General portfolio data Risk assessment Performance scenario returns Costs (table 2) Narratives in base language of the portfolio Identification data Price or benchmark history / raw data of the portfolio (potentially sliced benchmark data) to allow risk and performance calculation by the PRIIP manufacture Identification data Base EPT equivalent narratives for languages else than base languages Format: CSV or XML ( fundxml?) Interval: Monthly? Identification data Pre-calculated figures Risk (SRI) Performance Scen. Cost (table 1) For different RHPs regular premium/ lump sum cost structures 22

23 Comfort- EPT (Version as of 2016/08/31 agreed by EWG) CEPT Prices: Article 14 c CEPT Translated Narratives: Article 14 a-c CEPT RHPs: Article 14 c-d Comfort information required under article 14 and its references of PRIIPs final RTS with Article 14 the following links: Specific information on each underlying investment option In relation to the specific information referred to in Articles 11, 12 and 13, PRIIP manufacturers shall include for each underlying investment option all of the following: (a) a comprehension alert, where relevant; (b) the investment objectives, the means for achieving them, and the intended target market in accordance with paragraphs 2 and 3 of Article 2; (c) a summary risk indicator and narrative, and performance scenarios in accordance with Article 3; (d) a presentation of the costs in accordance with Article 5. 23

24 This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representati on or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, KNEIP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. 6 October, KNEIP All rights reserved 24

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