UK rules will diverge from the much-criticised EU framework.
On 20 July 2021, the FCA published a Consultation Paper (CP21/23) on amending the UK PRIIPs Regulation. The FCA has long held concerns about the PRIIPs framework, and pre-Brexit had been heavily involved in efforts to persuade EU lawmakers to amend the rules. The UK government and the FCA had indicated that the UK PRIIPs Regulation would be a priority area for change post-Brexit, given the consumer protection concerns arising as a result of ambiguities and unintended consequences of the rules. Now that the FCA has the flexibility to amend the regime, the regulator is looking at how it can address some of the most serious concerns, which will come as welcome relief to market participants.
Scope of the PRIIPs Framework
What is the issue?
While the scope of products caught by the PRIIPs Regulation has been clear in many cases, significant uncertainty has arisen in relation to corporate bonds. This uncertainty has led many issuers to exclude retail investors from their offerings to avoid the requirement to produce a PRIIPs KID.
The definition of a PRIIP includes an investment in which “the amount repayable to the retail investor is subject to fluctuations because of exposure to reference values or to the performance of one or more assets that are not directly purchased by the retail investor”. There has been confusion over the status of corporate bonds that include common features such as put or call options, as arguably such features make the amount repayable to the investor subject to fluctuations, causing the instrument to fall within the definition of a PRIIP.
The European Supervisory Authorities (ESAs) tried to alleviate this issue in 2019 by publishing guidance that indicates which bond features would not necessarily lead to a conclusion that a bond is a PRIIP. However, as the guidance is not legally binding, many issuers have been unwilling to rely on it in practice.
Market participants have also raised concerns about the application of the PRIIPs regime to “legacy” products issued before the PRIIPs Regulation came into force on 1 January 2018, but which may still be available for trading on secondary markets.
What changes is the FCA proposing?
The Financial Services Act 2021 allows the FCA to specify whether a product can be classified as a PRIIP under the UK PRIIPs Regulation. Therefore, the FCA is planning to make rules, broadly aligned with the guidance from the ESAs, clarifying that certain features do, or do not, make a product a PRIIP.
Clarifications proposed by the FCA include:
- A debt security is not a PRIIP if the overall return for the investor is determined by the economic performance of the commercial or industrial activities of the issuer
- A debt security with a fixed coupon is not a PRIIP, even if the coupon is subject to pre-defined changes
- Inclusion of a put or call option does not make the debt security a PRIIP, provided the option is not exercisable in response to fluctuations in reference values or the performance or one or more investment assets
- A debt security will not be a PRIIP simply by virtue of having a perpetual or indefinite term, or because of its subordination in the creditor hierarchy in the event of the issuer’s insolvency
The FCA intends to deal with the legacy-products issue by specifying that any financial instrument issued or sold before 1 January 2018 is not a PRIIP, even if it remains available for trading on a secondary market.
Corporate bond issuers would highly welcome these changes, providing clarity so that issuers would no longer have to exclude retail investors from their offerings.
In addition, the FCA intends to clarify when a PRIIP is considered to be “made available” to retail investors in the UK, which is the trigger for the requirement to produce a KID. Currently, the meaning of this term is ambiguous, and so the FCA proposes to set out the conditions a PRIIP manufacturer or distributor must meet to demonstrate that a PRIIP is not being made available to retail investors. These conditions include:
- The marketing materials make clear that the PRIIP is being offered only to investors eligible for categorisation as professional clients or eligible counterparties and that the PRIIP is not intended for retail investors
- The marketing and distribution strategy for the PRIIP is in fact targeted at professional and eligible counterparty clients and not retail clients
- The PRIIP is issued at a minimum denomination value of £100,000 (or equivalent sum in foreign currency)
Information in the PRIIPs KID
What is the issue?
The PRIIPs Regulatory Technical Standards (RTS) set out very prescriptive requirements for what a KID must contain and how that information must be produced. However, the FCA is concerned that the production and presentation of performance scenarios and summary risk indicators (SRIs) can, for some products, result in “seriously misleading” information in the KID. This leads to a conflict between the requirements of the PRIIPs RTS and the duty to ensure that information in the KID is accurate, clear, fair, and not misleading.
What changes is the FCA proposing?
The Financial Services Act 2021 removed the reference to “performance scenarios” and provides a more flexible requirement that the KID should contain “information on performance”, to be defined by the FCA. The FCA is proposing to remove the requirement in the RTS for PRIIP manufacturers to include performance scenarios in the KID, and add a requirement to include a narrative description of performance. The FCA is seeking views as to whether it should identify the factors that PRIIP manufacturers should include as part of this narrative section. The FCA is also gathering feedback as to whether including past performance information would be beneficial.
In relation to SRIs, the FCA is proposing to introduce a requirement in the RTS requiring PRIIP manufacturers to upgrade a product’s SRI if they consider that the risk rating produced by the current methodology is too low. Manufacturers upgrading a product’s SRI would be required to notify the FCA of this fact by email. The FCA is also planning to extend the current 200-character limit for the free-text section for other significant risks not covered in the SRI score calculations to 400 characters.
Transaction Cost Disclosures
The FCA is seeking to address specific issues arising from transaction cost reporting. The regulator’s proposed changes address the treatment of anti-dilution benefits, the calculation of transaction costs for debt securities, the calculation of transaction costs for index-tracking funds, and the correct method for calculating average transaction costs. However, the FCA notes that it does not intend to reopen the discussion of whether “slippage” is an appropriate measure for the purposes of PRIIPs transaction cost disclosures.
The consultation runs until 30 September 2021, and the FCA plans for the changes to come into effect on 1 January 2022. Separately, HM Treasury is planning to review disclosure requirements in retail markets more generally, which could impact the UK PRIIPs framework in future.
In the EU, although the ESAs have tried to correct some of the issues with the PRIIPs regime, their powers are limited. As such, market participants feel that a review of the Level 1 legislative text is necessary to address the key problems. Such a review has been long awaited, and the European Commission has committed to complete its assessment of the framework by early 2022. In the meantime, the ESAs have proposed some targeted amendments to the PRIIPs RTS, which would take effect from 1 January 2022.