This month, the European Parliament resumes the debate on Packaged Retail Investment Products (PRIPs), a draft regulation that proposes a “key information document” for products such as investment funds, life insurance, retail structured products, and certain types of pension schemes. To coincide with the parliamentary negotiation and to inform regulatory developments, CFA Institute has published a report on PRIPs that seeks to clarify what information is relevant to investors at the point of sale, particularly in the often-overlooked area of costs.
The legislative proposals on PRIPs disclosures are part of a series of measures designed to better protect investors and thereby help reduce the incidence of product mis-selling. By equipping investors with more useful information that is comparable among different types of PRIPs, retail investors should be less likely to purchase unsuitable products, particularly if these transparency measures are bolstered by other initiatives addressing product distribution.
Given the number and diversity of retail investment products, developing a standardised disclosure framework that allows for meaningful comparison is certainly challenging. A particular challenge relates to the disclosure of costs. Retail investors often have difficulty understanding the effect of costs on investment returns over different time horizons; consequently, costs are often overlooked or are not given sufficient weight in the investment decision-making process, resulting in suboptimal investment decisions or the selection of unsuitable products.
To further the aim of improving product transparency in the area of costs, CFA Institute analysed the main characteristics of different PRIPs and examined the form and content of existing cost disclosures, drawing from examples among European Union countries. On the basis of this analysis, the report sets out policy recommendations for cost disclosures and addresses other considerations for the PRIPs KID.
PRIPs Policy Recommendations
In total, the report contains 14 recommendations that address the scope of the PRIPs regulation, the format of the KID, and disclosures in the areas of costs, risks, and performance. The key considerations are as follows:
The initial scope of the PRIPs regulation should be packaged products that provide for exposure to the performance of an underlying investment portfolio or other assets. If, after review, the initial PRIPs KID is successful with consumers, the scope could be extended beyond packaged products.
- Costs should be disclosed under a standard label and location within the KID, but the content of cost disclosures could embody a small degree of flexibility beyond common components such as entry fees, exit fees, ongoing charges, performance fees, transfer fees and any penalties, or other administrative charges.
- Costs disclosures should include a statement, where relevant, specifying the total amount in percentage terms the product manufacturer or sponsor pays for distribution arrangements (inducements).
- For life insurance products, a table illustrating the effect of costs in monetary terms over predefined time horizons should be provided. Cost disclosures for structured products should include a narrative explanation of the total costs included within the amount paid for the product.
- The risk of the product, as reflected in the risk indicator, should be based upon its volatility, such as the standard deviation of returns. Where such calculations are not possible the KID should provide for adequate explanations and disclosures of risks.
- In the case of products with set maturities and predefined payoffs (such as structured products), risk should be measured with regard to the variability or range of possible outcomes at maturity, with appropriate disclosure of how this risk may vary during the life of the product.
- Narrative disclosures should also include details of significant risks arising from the investment strategy of the product, details of any national financial compensation scheme protecting investors in the event of default or failure of the product manufacturer, and details of the creditworthiness of the issuer where appropriate.
- Data should be presented in the form of a bar chart that shows yearly net performance in percentage terms, alongside relevant narrative disclosures.
- For structured or guaranteed products and funds, which have predefined payoffs, a tabular presentation of performance scenarios would be appropriate in place of past performance data (located under a different section of the KID).
The PRIPs regulation is an important initiative premised upon protecting investors and improving transparency. Getting the disclosure framework right is a necessary (if not sufficient) step to empower consumers to make more informed decisions. As policy makers re-engage the debate on PRIPs, investor disclosure considerations should remain at the forefront.
Blog post updated 28 October 2013.
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