What is the significance of PRIIPs and what does it mean for asset managers?
The Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation is a new law due to come into force in December 2016 that applies to all financial products sold to retail clients that are packaged, so that includes structured deposits, certain insurance products, and over-the-counter products such as options and warrants.
As soon as a product is packaged, the provider will have to present investors with the new Key Investor Documents (KID), which will eventually replace the Key Investor Information Document (KIID), but this should not happen before 2019.
The original KIID was born out of UCITS IV. It’s a simplified two-page document that has to be shown to the investor before any investment is finalised. It has to be written in plain language, it’s standardised, and it’s designed so that anyone on the street should be able to understand it and effectively compare products. Essentially, it is all about increasing transparency.
With UCITS III, a similar idea was trialled; the simplified prospectus. Before that, the only document an investor would receive before committing to the investment was the prospectus written up by legal teams, and that could be 100 pages or more. Today, it is still difficult to understand, unless you are a financial expert or specialised lawyer.
The simplified prospectus was designed to be a lighter version of this, but in the end it failed and became just as complicated as the main document. The European Commission then came up with the KIID, which in many ways went to the other extreme. It’s an even more simplified document that has to describe the product, which is often very complex, in just two pages, and in plain language.
At the moment the KIID is only applicable to UCITS funds, so PRIIPS asks for similar documentation for all financial instruments—although the KID allows for an additional page of information.
Is there a danger that complex products might become over-simplified, and that significant details could be left out?
Obviously there is a responsibility to investors here, and avoiding over-simplification is a big part of that. Complex doesn’t necessarily mean risky, but sometimes investors can get them mixed up, especially those outside of the financial industry. They see something very complex and assume that, by nature, it’s risky. The challenge we have now is that if we have a very complex instrument that’s hard to explain in ‘plain’ terms, there is a risk of over-simplifying things.
If we compare it to the pharmaceutical industry, patients allow doctors to prescribe medicine if they are ill, but most patients probably will not understand what is in the drugs they’re given. The argument is that you don’t have to understand, but you have to have trust.
This is obviously where we have a problem, because the trust has been lost since 2008, and politicians and regulators believe that market participants can no longer be trusted. There are many valuable, honest people in this industry, although, of course, we have seen a few instances where this has not been the case. Even so, I’m not sure if over-simplification will really help to reduce risk.
Is there a balance to be struck between over-complicating and over-simplifying? How do we find the optimal level of transparency?
There is, certainly. Again, if you are sick, you go to the doctor, you seek expert advice. The same principle should apply to the investment managers who are experts in their fields. It is true that the industry has not been transparent enough in the past, but because there have been a few serious incidents, it is at risk of going too far to the opposite extreme.
Finding the middle ground depends a lot on the financial advisors. They need to know which product is suitable for which investor, which is part of what PRIIPs is trying to achieve, and is actually mandated under the Markets in Financial Instruments Directive (MiFID) II regulation. Regulators are going to lengths to try and align products and investors.
I must admit, however, that it is a difficult situation. At the end of the day, the industry has to protect investors, but on the other side of things, advisors have to have some responsibility over what happens to that investment. There comes a point where I don’t believe simplicity and transparency will help any more, but this is how the world is now, and unfortunately, firms must either work out how best to deal with it or go out of business.
What’s next for asset managers?
At the moment, some managers look at regulation vertically, regulation by regulation, but I think they should start approaching it more horizontally, which means looking at themes of data and how they affect each regulation.
There will be some more massive regulations coming our way, and for asset managers to cope with that they will have to either invest a lot in to the relevant technology or outsource some of these functions.
That’s where outsourcing to a company like KNEIP can make sense. We are making the investment in technology and people because this is our core business.
With documents like the KIID, and PRIIPS when it comes in, we can produce those and help asset managers to disseminate them to the appropriate regulators, distributors, data vendors and platforms.
The same information can be used for multiple purposes, and managers should be moving in that direction to make sure they get the best efficiency while coping with regulation.
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