October 2016

PRIIPS: Brussels got its maths wrong

When politicians kicked out proposals for how Priips would work in practice, it was momentous. Kit Klarenberg reports on what led to the dissent.

On September 14 this year, the European Parliament voted overwhelmingly against a set of proposed ‘regulatory technical standards’ (RTS) that would determine what details retail investors should be told in product literature.

These details – once finalised – would appear in the Key Information Documents (Kids) within any fund covered by the Packaged Retail and Insurance-based Investment Products (Priips) regulations.

Following the defeat, Syed Kamall, UK Conservative MEP and a prominent opponent of the measures, said: “This is the first time Parliament has used its powers to reject technical standards, but we’ve been left with no choice but to press the nuclear button.”

The vote followed a recommendation from the European Parliament’s Committee on Economic and Monetary Affairs to reject the proposals earlier that month. The move was also momentous; it was the first time ever the Committee had shunned Commission proposals, and only the fifth time any Committee has defied the EU’s executive body.

In all, the vote in Strasbourg was carried by 602 to four – a 99.4% majority. The historic, landslide rebuff was applauded across the European asset management sphere, with many firms and associations publicly voicing support in its aftermath. Evidently, the measures were immensely unpopular with legislators and the industry alike. Why?

HISTORY IS BUNK
The litany of objections lodged by industry stakeholders since the draft publication of the proposals in March this year is lengthy. However, the lion’s share of criticism has centred on the Commission’s plans for performance data.

First and foremost, under the proposed RTS, asset managers would no longer be obliged to disclose a fund’s past performance in the Kids – or even divulge how that fund’s benchmark has performed.

“This would by definition prevent investors from knowing whether a product has made or lost money in the past, and whether it has ever met its stated investment objective or promise – it would also make comparing similar products, such as index and index-benchmarked funds, far more difficult, if not impossible,” says Guillaume Prache, managing director of investor advocacy group Better Finance.

“We’ve never seen such poorly drafted rules in financial services legislation before. They’re also grossly inconsistent with the EU’s initiative for a Capital Markets Union, which explicitly calls for greater transparency on the past performance of long-term savings products. It’s extremely good news Parliament voted them down.”

The importance of past performance data is a contentious issue in investment management; some consider it a highly deceptive metric that can result in investors making poor choices, others an indispensable resource for judging the record of a product or manager. Florian van Megen, retail markets specialist at the UK Investment Association, is in the latter camp.

“A factual history of how a fund has hitherto fared is key for gauging credibility, making it an important resource for investors, and funds too,” he says.

“The Commission’s move to eliminate these requirements was a big mistake, and an odd one too; if the industry itself had called for such a thing, regulators would’ve surely vetoed them.”

While recognising the inherent limitations of past performance, Andreas Stepnitzka, senior regulatory policy advisor at the European Fund and Asset Management Association (Efama), likewise opposed the removal of this information from Kids.

“It’s important for investors to know how a product has performed in the past. While not necessarily an indication of future performance, it’s at least based on historical fact, and presented in a standardised way that allows for easy comparisons,” he says.

Whatever one makes of the requirements, what the Commission sought to replace them with has proven more controversial. If the rules had come to pass, fund houses would’ve been required to project how a vehicle was expected to perform in future in three market scenarios: unfavourable, moderate and favourable.

While perhaps a laudable objective in principle, serious concerns were raised about the methodology that would have been employed to calculate this performance.

Sven Giegold, a German Green MEP, tested the actual performance of a number of assets and funds over the past two decades against the formulas and found they consistently delivered “overly optimistic” results, which would serve to seriously mislead investors.

“My comparisons show the ‘unfavourable’ scenarios perform better than reality – the projection formulas consistently show a profit for products in scenarios when the actual result was a loss,” he says.

“These rules would mean investors were supplied with inaccurate material – a direct breach of key EU consumer protection regulations, which demand clear, fair and non-misleading information is supplied with financial products. I’m not opposed to people taking risks, but I am opposed to people losing money based on misleading information.”

The value of financial products that fall under Priips rules is €10 trillion; the prospect of some or all of that capital being at risk due to investors being given incorrect information by law is an extremely troubling one. Giegold is not alone in having identified serious issues with the formulas; Stepnitzka says Efama’s own analysis also uncovered misleading results. Moreover, the trade group has major concerns about the proposals’ calculation of transaction costs.

“A key element of the proposed Kids is they will include transaction costs in the overall cost disclosure. The RTS are meant to provide a common methodology for the calculation of those transaction costs, but unfortunately, the proposal is not workable,” he says.

“This is because the methodology is based on market data that cannot be obtained before the [Markets in Financial Instruments Directive II and supporting regulation] comes into force, and more importantly, because the proposed method of calculation means the costs disclosed include not just actual costs, but also market movements.”

Stepnitzka adds that the newly proposed transaction costs would include changes in market price from the moment a buy or sell decision is made to deal, and the price at which a transaction actually takes place. Efama believes this does not provide useful information by which managers can be held to account, since market fluctuations are outside a manager’s control.

“It could also lead in certain circumstances to negative transactions costs, which does not reflect reality and would therefore be misleading to investors,” he says.

BACK TO THE FUTURE
An obvious riddle at the core of this controversy is why the Commission stubbornly pursued such universally unpopular measures. An MEP, who asked to remain anonymous, suggests lobbying from certain industry quarters might have played a role.

“It can only be speculation on my part, but I suspect representations were made to the Commission by some firms on this issue. My office was approached by a group of businesses last year – their pitch was that it was in the interests of consumers to dump past performance, and future performance was pushed heavily,” the parliamentarian claims.

While the vision of a shadowy asset management cabal cutting deals in smoke-filled rooms for
its own purposes is a titillating one, this scenario seems thoroughly at odds with the widespread relief evident throughout the industry when the proposals failed in Parliament.

Moreover, in the months preceding the vote, Europe’s biggest asset managers were the most prominent opponents of the proposals; in June, an octet of fund firms, including Axa Investment Management, BlackRock and Schroders, wrote to the Commission asking them to amend the draft rules.

The letter stated the proposals were “not evidenced-based, will not help consumers, and will not command respect”.

The likely reality is dully non-conspiratorial – the Commission was simply in a rush to get the finer points of Priips settled by December 31, when the regulation is scheduled to come into force. The defeat of the rules in Parliament now raises the prospect that Priips won’t be ready before the end of this year, meaning implementation will be pushed into 2017. Many would welcome a deferral.

“It’s clear the Commission should postpone the entry date. We would recommend delaying by another 12 months, which would align the timeline for Priips with the entry into force of the new MiFID regime – this makes sense given the number of overlaps in both frameworks,” says Thomas Richter, chief executive of German investment funds association BVI. 

Still, a delay is not yet certain – the Commission has suggested a new draft could be complete by October. On the same day the RTS were defeated in Parliament, Silverfinch, a technology firm, held a discussion event in London that explored and discussed the regulation in detail.

Many expert panellists, including representatives of the UK Investment Association and EY, were confident Priips would achieve lift-off by January 1 next year.

Due to this ambiguity, Mario Mantrisi, chief strategy & research officer at Kneip, says firms affected by Priips must not pause their preparations.

“We surveyed around 60 financial services firms on the subject in August, and found Priips has caught many of them off-guard – 85% of respondents said the short time they have to produce new Priips Kids was a primary concern for their companies,” he says.

Of course, if the implementation date of December 31 remains in place, firms will have one less month in which to produce Priips-compliant documentation for their products. Still, this is a development the industry should welcome in theory – as Giegold says, Priips is a positive piece of legislation for the industry, “promoting healthy competition across borders, and improving investor choice”.

What’s more, it’s evident that requirements around future performance forecasts cannot endure any longer – if their crushing defeat wasn’t enough to eliminate them, a majority of MEPs are continuing to push for abandonment. The general consensus among the Committee on Economic and Monetary Affairs is that Priips will go ahead as before, minus these projections. Of course, this leaves the question of whether past performance will be maintained very much up in the air.

Watch this space.

©2016 funds europe