This month the Financial Conduct Authority (FCA) published the new disclosure rules for packaged retail and insurance-based investment products (PRIIPs) in line with EU Regulation 1286/2014 (PRIIPs Regulation) in its Policy Statement PS17/6 (PS). The PS is intended to give firms sufficient guidance to allow them to prepare for the implementation of the PRIIPs Regulation on 1 January 2018. In this briefing we consider some of the key points of the PS and how they will affect firms within the scope of the PRIIPs Regulation.
Together with the FCA's PRIIPs Consultation Paper (CP16/18) the PS sets out how the FCA's disclosure regime in relation to the PRIIPs Regulation will be implemented. As the PRIIPs Regulation is directly applicable it does not need transposing into UK law. Instead, the FCA has amended its new disclosure framework to refer to the new PRIIPs requirements and has updated any conflicting provisions.
Essentially, this means that from 1 January 2018, the FCA will require firms to prepare, publish and provide a key information document (KID) before each PRIIP is made available to a retail client, as well as comply with other relevant provisions of the FCA Handbook and EU law.
What is a PRIIP?
In essence the definition of a PRIIP, as set out in the PRIIPs Regulation, is an investment or insurance product where the amount repayable to the retail investor at the end of the investment period may vary because the product is exposed to reference values or to the performance of underlying assets not bought directly by the retail investor.
The FCA believes that most PRIIPs should be easily identifiable as such and it further notes that it is up to each firm manufacturing a product to decide whether it is a PRIIP or not. However the FCA acknowledges that classifying a product as a PRIIP might not always be straightforward, and Annex 2 of the PS includes lists of the types of products likely to be regarded as PRIIPs and non-PRIIPs. It is worth noting that since publishing the PS, the FCA has slightly updated the list on its PRIIPs webpage. Further, the definition of PRIIPs may be subject to further clarification by the European Supervisory Authorities (ESAs) or the European Commission during the course of 2017.
As expected products that are likely to fall within the definition of PRIIPs include:
- units in (authorised and unauthorised) funds, structured deposits; and
- debt securities where the amount repayable is subject to fluctuations because of exposure to reference values or to the performance of one or more assets which are not directly purchased by the investor.
Products which are not likely to fall within the PRIIPs definition include:
- non-life insurance/general insurance and life insurance products that have no surrender value;
- assets that are held directly by the retail investor, such as corporate shares or sovereign bonds;
- debentures and other debt securities where the amount repayable to the retail investor is fixed; and
- ISA wrappers (although see below for further information).
Who will the new rules apply to?
The FCA envisages that the new disclosure rules will apply to most firms that manufacture, provide, advise on, or sell PRIIPs to retail investors in the UK market in the following ways:
- firms that manufacture PRIIPs (eg fund managers) will need to prepare KIDs for each PRIIP manufactured and publish these KIDs on their website;
- firms that distribute PRIIPs will need to prepare and publish a KID if that distributor makes changes to a PRIIP including for example, altering its risk and reward profile or the costs associated with an investment in a PRIIP (and therefore making themselves a manufacturer for the purposes of the PRIIPs Regulation);
- firms that give advice on or sell a PRIIP (without making any changes) will need to provide a KID for that PRIIP which will be prepared by the manufacturer.
Form and content of the KID
The form and content of the KID is directed by the PRIIPs Regulation and related Regulatory Technical Standards. Firms will need to prepare a KID for each PRIIP before it is "made available" to retail clients. The KID must be no more than three A4 sides and must address the following questions:
(1) What is the product?
(2) What are the risks and what could I get in return?
(3) What happens if the PRIIP manufacturer is unable to pay out?
(4) What are the costs?
(5) How long should I hold it and can I take money out early?
(6) How can I complain?
(7) Other relevant information.
The definition of being "made available" has not been expanded on in the PRIIPs Regulation, and several queries were raised by respondents to the CP as to how they should interpret "made available". For example, what obligation is a product manufacturer under when they create a product that is not designed for retail investors but could be accessed by them through a secondary market? In addition, respondents were keen to ascertain what the obligation is in relation to legacy and closed book business products which are no longer open to retail investors but fall within the new PRIIPs definition. The FCA agreed that the PRIIPs Regulation does not provide for transitional arrangements for such products and acknowledges that these are "areas of uncertainty for firms". The FCA's view is that clarity should be provided by the European Commission or the ESAs, and the FCA will continue to work with these bodies to try to achieve such clarity.
In terms of presentation of the KID, the PRIIPs Regulation requires that KIDs must be produced in colours that can be read without "diminished comprehensibility" when printed and/or photocopied into black and white. The FCA will extend this requirement as guidance to non PRIIPs disclosure documents as well.
Clarification on the scope of the PRIIPs Regulation
In the PS, the FCA considers the responses received from the CP, and sheds useful insight on the scope of the PRIIPs Regulation. In particular, the FCA has made the following helpful clarifications.
(1) An Individual Savings Account (ISA) wrapper does not itself fall within the PRIIPs definition and as such, a KID will not be needed for an ISA. However, products held within the ISA may well be PRIIPs for which KIDs are required.
(2) Generally, the provision of dealing, portfolio management and custody services will not require a KID, though the investments acquired through such services will often be PRIIPs, for which KIDs will be required.
(3) Normally, the manager of an AIF (AIFM) will be considered to be the PRIIP manufacturer. However, where an AIF has appointed an external AIFM while unusually remaining responsible for its own marketing (and has suitable governance arrangements independent of the AIFM) the AIF itself may be regarded as its own PRIIPs manufacturer and will be responsible for the preparation and distribution of the KID.
(4) It is worth noting that costs associated with the ISA wrapper and the investment service will need to be disclosed in a separate document, if not reflected in the costs disclosed in the KID.
The FCA's stance on third country issues remains as it was set out in the CP. The FCA believes that third country manufacturers or distributors of a PRIIP to retail clients in the EEA will be required to prepare and produce a KID. In practice, this means that before authorised firms can sell or advise on a PRIIP manufactured outside the EEA to UK retail clients, they will need to provide KIDs to their UK retail clients.
In contrast, if the manufacturer or distributor is based in the EEA and targets only non-EEA retail clients, the FCA believe that the PRIIPs Regulation will not apply and no KID will need to be prepared.
How will the new disclosure rules coincide with the existing regime?
Currently, relevant firms are required to prepare and provide a key features document (KFD) and a key features illustration (KFI) for each 'packaged product' they produce. The definition of 'packaged product' includes products that will be PRIIPs and non-PRIIPs. The FCA have confirmed that from 1 January 2018, the KFI and KFD models will no longer apply to 'packaged products' that are also PRIIPs; the KID regime will replace it. For those 'packaged products' that are not also PRIIPs, the KFD and KFI regime will remain.
The KID will also replace the NURS key investor information document (NURS-KII) and the key investor information document (KIID) required for UCITS. Firms that are authorised fund managers of NURS and UCITS management companies will be required to replace the NURS-KIIs and KIIDs as applicable with the PRIIPs KID after a transitional period which ends on 31 December 2019. However, there is an additional wrinkle for managers of NURS funds. If such firms choose to retain the NURS-KII during the transitional period, they should be aware that the FCA is modifying the NURS-KII requirements slightly and that authorised fund managers that opt to use a NURS-KII rather than a KID from 1 January 2018 will have just 35 working days from the end of 2017 to replace their existing NURS-KII document in line with the modifications set out in the FCA handbook at COLL Appendix 2R.
Impact for firms
While there are a number of key points that remain outstanding, such as the extent to which the PRIIPs rules will apply to secondary markets, top-ups for existing products and closed-book products, firms should not wait for this guidance before undertaking their PRIIPs preparation. The FCA is of the view that the publication of the PS provides firms with sufficient guidance to carry out the necessary implementation work to classify their products and prepare or arrange to receive the appropriate KIDs in good time to ensure that they can comply with the PRIIPs Regulation from 1 January 2018. However firms should still be alert to the prospect of further guidance from both Europe and the FCA throughout 2017.
In addition firms will need to consider the extent to which they will need to run a dual disclosure system (ie produce or source investor disclosure documents for "packaged products" that do not fall within the scope of the PRIIPs Regulation). Further firms which intend to take advantage of the transitional provisions for NURS-KIIs mentioned in the paragraph above need to be aware of the modifications to the NURS-KII that the FCA are implementing and plan accordingly.
Taken together with the MiFID II implementation work that many firms will be carrying out this will mean a busy autumn for many in the financial services sector.
Conclusion and next steps
The PS provides some useful clarification and the made rules in the Annex are unlikely to vary significantly even in the event of further guidance from Europe and the FCA. The PRIIPs Regulation aims to improve the quality of the information available to retail investors and as a standardised document it is hoped that investors will be more easily able to compare products and thereby make better investment choices. However, from an investor's point of view they may well need to continue to compare different styles of document with varying content requirements as the KFI and KFD regimes will continue for non PRIIPs "packaged products".
In terms of the looking beyond Brexit, the FCA expects that the PRIIPs Regulation will form part of the body of EU law that will be converted into domestic law following the UK's departure from the EU.
If you require further information on anything covered in this briefing please contact Grania Baird (firstname.lastname@example.org; +44(0)203 375 7443), Fiona Lowrie (email@example.com; +44(0)203 375 7232), Rebecca Price (firstname.lastname@example.org; +44(0)203 375 7815) or your usual contact at the firm on 020 3375 7000. Further information can also be found on the Compliance and Regulatory page on our website.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, May 2017