«CONSULTATION PAPER ON PRIIPs KEY INFORMATION DOCUMENTS - AMAFI's response Introduction Please make your introductory comments below, if any: ...»
AMAFI / 16-10
27 January 2016
CONSULTATION PAPER ON
PRIIPs KEY INFORMATION DOCUMENTS
Please make your introductory comments below, if any:
Association française des marchés financiers (AMAFI) is the trade organisation working at national,
European and international levels to represent financial market participants in France. It acts on behalf of credit institutions, investment firms and trading and post-trade infrastructures, regardless of where they operate or where their clients or counterparties are located. AMAFI has more than 120 members operating for their own account or for clients in different segments, particularly organised and over-the- counter markets for equities, fixed-income products and derivatives. Nearly one-third of its members are subsidiaries or branches of non-French institutions.
Prior to answering to the specific questions in the Joint Consultation Paper, AMAFI would like to draw the
Joint Committee’s attention on the following issues:
1. The methodology for classifying PRIIPs Categories is complex, and the MRM methodology for structured products relies on concepts that are not well established as market practices.
In AMAFI's view, the proposed methodology for presenting risk in general and market risk in particular is over-complicated because the system for categorising products, especially derivatives (see below), is ill- defined and, in some cases, sketchy. The proposal, which blends a qualitative approach with a quantitative approach depending on the type of product, is anything but a uniform solution for comparing and contrasting products. And yet, such is the aim of the PRIIPS Regulation.
AMAFI also wishes to point out that the risk indicator methodology chosen for structured products (Category III PRIIPs), i.e. bootstrapping of historical data, which was not an option in the previous consultation, does not seem to be widely used by market participants. Moreover, it is not the same as the methodology used for UCITS, which is based on the Black-Scholes model.
With this in mind, AMAFI has identified a number of drawbacks:
- Increasing the number of models according to product categories makes it hard to understand and interpret the PRIIPS system as a whole;
- For market participants dealing multiple products, setting up this kind of mechanism will be an unwieldy process fraught with operational difficulties;
- Using multiple models would frustrate the main aim of the Regulation, which is to facilitate product comparison;
- Reliance on little-used methods would complicate not only the test phase but also the IT developments that are a prerequisite for bringing market participants into compliance with the Regulation. This raises yet again the issue of the planned applicability date for these measures (see point 5).
2. Derivatives are hazily defined AMAFI points out that the definition of "derivatives qualifying as a PRIIP" is extremely broad, and therefore hazy because these products would automatically be placed in the same category as the riskiest instruments. It also raises the question of the scope of PRIIPS and the fact that non-investment products should be excluded since an option or a future do not imply investment of cash from the “investor” (see point 6 below).
Additionally, AMAFI believes that a specific SRI of “7+” or a “7 complemented by a specific label category should be confined on which investors could lose more than their initial outlay.
3. The concepts in the paper need further clarification, particularly the presentation of costs Several key concepts in the Consultation Paper need to be clarified if the PRIIPS mechanism is to be
uniformly understood. This applies in particular to:
- Reduction in Yield (RIY), which requires further explanations ;
- Fair value (e.g. does this include the cost of hedging the product?). In particular, the Consultation Paper seems to make no link between fair value and RIY. We recommend the RTS should clearly draw a link between fair value and RIY, and explain it through examples and/or formulas;
- Structuring costs, which requires precisions.
In AMAFI's view, if more information on these concepts is to be provided in the final RTS, or Level 3 Guidelines, then they should be published in the near future so that market participants can comply with the Regulation.
4. Performance scenarios interim holding period The Consultation Paper requires the scenarios to be based on the "recommended holding period", as well as two other scenarios are to be displayed for shorter “interim holding periods”. For structured products or any PRIIP with a fixed maturity date valued using a model, interim scenarios do not make much sense, because the payoff is only valid at the maturity/redemption date. Moreover, the section “How long should I hold it and can I take my money out early” already highlights the capital risk in case of an early redemption or a buy back on the secondary market.
Therefore, AMAFI asks that the exemption to display interim actually includes all PRIIP with fixed maturity dates.
Incidentally, further clarification on the methodology that is to be used for selecting the three scenarios in Annex IV for choosing between favourable, moderate and unfavourable scenarios would be welcome.
5. Postponing the entry into force of the PRIIPS Regulation should at least be considered AMAFI insists that postponing the entry into force of the Regulation should at least be considered, because although potentially far-reaching IT developments will be needed, discussions are ongoing.
More-over, there are connections to be made with the MiFID II investor protection measures, such as information on costs and fees and the definition of the target market, which are among the obligations provided for in the product governance arrangements.
The postponement issue is especially important for producers, who will have to be up and running several months before the new measures actually come into force. Yet the Consultation Paper does not answer all the practical and theoretical questions about the work that will be needed to comply with the new Regulation (see also answer to Question 28).
AMAFI is calling at the very least for a grace period or a transition period in order to make up for the absence of a grandfather clause for products that were designed before the Regulation comes into force and that might be offered to clients or to the general public (in the case of the secondary market) once it has taken effect.
6. The scope of PRIIPs is inappropriate in view of the type of products covered
AMAFI repeats its comments about the very broad scope of products covered by PRIIPS and the difficulties involved in applying the Regulation to instruments that are not investment products. This issue concerns, for instance, a number of foreign exchange or fixed income products sold to corporate clients for the sole purpose of hedging and not investing. The KID template in the proposed RTS is not fit for hedging products. More specifically, the section “How long should I hold it and can I take my money out early?” and RIY calculations do not make sense for such hedging products.
Whereas there is no specific indication in the Consultation Paper about the scope of the PRIIPs Regulation, AMAFI wishes to highlight once again that convertible bonds and any OTC derivatives should not be included in the scope.
However, as regards convertible bonds, contrary to the definition of PRIIPs, these products are not designed “to provide investment opportunities to retail investors” (PRIIPs Regulation, Recital 6); their primary purpose is to meet the financing needs of their issuers, not the investment needs of retail investors. Convertibles are governed by the rules applicable to financing instruments, so there is no reason to distinguish them from corporate shares or bonds, which are outside the scope of the Regulation. For instance, the cost structure for convertible bond is different to the structure for other PRIIPs since it does not include the implicit costs paid by the investors. Indeed, investors buy convertible bond at its market price.
As regards, OTC derivatives, although AMAFI agrees that those intended for mass distribution, e.g.
CFDs, are within the scope of the Regulation, those contracted with corporate clients classified as retail
clients are not PRIIPs, for the following reasons:
- There is no distribution as such to retail investors, only a bilaterally negotiated contract;
There is no “investment opportunities” as such;
There is no repayable amount to the retail investor, as stated in the definition of a PRIIP;
- Some derivatives exposed solely to an interest rate are similar to fixed-rate or variable-rate deposits, which are outside the scope of PRIIPS.
In addition, since contract is different from the others, those OTC derivatives are not standard products ready for mass distribution to retail investors. Applying the requirement to produce a KID for these products would in effect mean that any single derivative contract with a client would require a KID, which seems disproportionate considering the lack of value added for the corporate clients concerned.
For these reasons, AMAFI considers that the Level 2 measures related to the PRIIPs Regulation should explicitly provide that convertible bonds, OTC derivative contracts that do not provide investment opportunities (such as hedging products) are not PRIIPs and that KIDs do not have to be drawn up for them.
Questions Question 1 Would you see merit in the ESAs clarifying further the criteria set out in Recital 18 mentioned above by way of guidelines?
AMAFI would support an ESA initiative to develop common complexity criteria, since this could usefully contribute to the harmonisation of product complexity rules and avoid fragmentation of the national regulatory regimes as it has been experienced in the past. However, such an initiative should be conducted in line within MiFID II work on product governance to ensure a consistent approach between both regulations.
Question 2 Would you agree with the assumptions used for the proposed default amounts? Are you of the opinion that these prescribed amounts should be amended? If yes, how and why?
Would you favour an approach in which the prescribed standardised amount is the default option, unless the PRIIP has a known required investment amount and price which can be used instead?
AMAFI disagrees that EUR 15,000 should be used for single premium insurance-based investment products. We believe that EUR 1,000 should be used for all types of PRIIPs (all insurance based, regular premium insurance products as well as single premium, UCITS/AIFs, and structured products) since it is standard market practice. It would ensure consistency and comparability between products.
Question 3 For PRIIPs that fall into category II and for which the Cornish Fisher expansion is used as a methodology to compute the VaR equivalent Volatility do you think a bootstrapping approach should be used instead? Please explain the reasons for your opinion?
AMAFI considers that the methodology chosen should produce similar result for a same payoff packaged under different medium, structured product or investment fund.
For category III, AMAFI members consider that the results achieved by bootstrapping are similar to those from the well-established Black and Scholes methodology. For category II, bootstrapping computation leads to similar results as those from the Cornish Fisher methodology.
In addition, due to its complexity and the fact that it is not standard market practice, AMAFI thinks that not all market participants fully understand bootstrapping methodology. Therefore, we do not see the benefit of implementing this “new” approach. Ultimately, it will imply more resources and time-consuming additional computations.
Question 4 Would you favour a different confidence interval to compute the VaR? If so, please explain which confidence interval you would use and state your reasons why.
If the VaR methodology is to be applied, AMAFI believes the related confidence interval could be wider than currently considered in order to provide differentiating results for the various product characteristics (e.g. soft-capital protection with different barrier levels).
In our opinion, it would be best to set a confidence interval of 5%.
Question 5 Are you of the view that the existence of a compensation or guarantee scheme should be taken into account in the credit risk assessment of a PRIIP? And if you agree, how would you propose to do so?
In AMAFI's view, protection schemes are essentially an external factor which arises only if the counterparty defaults; they are not an element of credit exposure per se. This militates against incorporating a compensation scheme cover into the credit risk assessment. To avoid confusion, AMAFI feels that an appropriate disclosure is a better solution, rather than having such schemes wrapped up in the credit risk assessment.
It should be noted that such disclosures should be added to the section "What happens if [the name of the PRIIP manufacturer] is unable to pay out?" rather than to the risk section.
Question 6 Would you favour PRIIP manufacturers having the option to voluntarily increase the disclosed SRI? In which circumstances? Would such an approach entail unintended consequences?
Although AMAFI does not have a firm view in favour or against such proposal, we consider it impossible at this stage to anticipate the unintended consequences of such an option. Generally speaking, if PRIIP manufacturers have the option to voluntarily increase the disclosed SRI, and if that option is used widely by manufacturers, the relevancy of the proposed SRI method is questionable. This situation could be detrimental for all the parties involved.