Articles - Derogation or Maybe Not?

For PRIIPs manufacturers, Article 14.2 of the Regulatory Technical Standards (RTS) provides an optional derogation until 31 December 2019 enabling them to use the UCITS KIID data in certain circumstances. Some insurers see the derogation as a way of minimising the shorter-term work required in implementing the PRIIPs regulations in a tight time-frame whereas other insurers have decided to bite the bullet and implement the PRIIPs regulations in full without derogation from 1 January 2018.

 By George McCutcheon Research Director at Financial Risk Solutions 

 The latter seems sensible particularly when the derogation is only for 24 months - why implement two new approaches in two years when a single implementation would suffice?

 A crucial point is that there is a very significant difference in terms of the information supplied to the customer depending on what option the insurer selects. If the insurer opts to avail of the derogation, the customer will effectively access an information document for the selected investment option which is a UCITS KIID generated by a third party. There would be no performance scenario figures, the costs disclosure would be in the UCITS format, the costs disclosed would exclude portfolio transaction costs and would exclude the PRIIP manufacturer product costs. This is in the context that in the UK, both KFDs and KFIs are not required for a PRIIP (including PRIIPs for which insurers have availed of the derogations). Post 1 January 2020, the same customer accessing the latest available specific information for the selected investment option would see a PRIIPs format presentation with performance scenario figures, a different format of costs disclosure, portfolio transaction costs included and the PRIIPs manufacturer product costs included. Clearly the potential civil liability exposure is increased in circumstances where the insurer has chosen to avail of an optional derogation which results in the specific information document not incorporating the full range of costs that would otherwise be disclosed under the PRIIPs basis. Some insurers may choose not to avail of the optional derogation solely based on a consideration of the potential civil liability exposure issues.

 There are other sound business reasons underpinning a decision not to avail of the derogation. To understand why, it is necessary to understand that there are two parts to the derogations included in Articles 10-14 of the RTS - firstly in respect of the provision of the specific information on an underlying investment option through UCITS KIIDs and secondly in respect of how the generic KID is compiled. The derogation in respect of the generic KID is available only in circumstances where UCITS or non-UCITS funds are the only underlying investment options – the Article 13(3) test.

 If a product fails the Article 13(3) test, there is no real merit in choosing to avail solely of the first part of the derogation. The reason for this is that most of the calculations required on a PRIIPs basis are required for the generic KID cost figures – it’s not a case of trying to overlay product costs and portfolio transaction costs onto supplied UCITS costs figures – in particular by definition the costs expressed on a reduction in yield basis are dependent on the investment returns inherent in the projections and so performance scenario calculations are required to derive the range of costs figures for the generic KID. In such circumstances, the best business decision is probably to implement the PRIIPs basis in full immediately from 1 January 2018. In practice, for most insurers their PRIIPs products will fail the Article 13(3) test e.g. open architecture products fail almost by definition and products with blended funds of UCITS fail (because there is no UCITS KIID corresponding to the blended fund).

 There remains a shorter list of insurers with PRIIPs products that might pass the Article 13(3) test. Those insurers would be offering products with underlying investment options where the customer is allocated units directly in the UCITS or allocated units in internal funds which each invest 100% into a UCITS – so-called mirror funds. Such insurers could avail of both parts of the derogation but would that be wise having regard to the civil liability exposure issues? Immediate implementation of the PRIIPs regulations in full without derogation from 1 January 2018 seems to be the best approach.

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