PRIIPs
 

In the PRIIPs KIDs, recurring costs, including the transaction costs, must be disclosed in percentage terms. The PRIIPs delegated act sets out how firms should calculate actual transaction costs: these costs must be determined using an “arrival price”, which requires firms to calculate the difference between the bid/ask midpoint price at the point at which a trade is first submitted, and the final execution price of the same trade. This means that the costs disclosed are often heavily influenced by market movements and, in some cases, have resulted in some firms disclosing negative figures for their transaction costs. These negative figures may lead investors to draw inaccurate conclusions about the desirability of certain funds and the true brokerage charges which they will ultimately bear.
 

MiFID II

MiFID II also requires that asset managers give estimates of their transaction costs for buying and selling securities. Unlike PRIIPs, the MIFID II rules do not set out a specific formula that firms must apply when calculating transaction costs. This means that firms are taking different approaches to calculating their transaction costs, undermining comparability. Furthermore, as firms do not have to disclose their underlying methodologies, it can prove impossible to determine how the final transaction cost figure has been calculated.

However, MiFID II does require that firms give investors transaction cost figures which reflect the price movement between the initial placement of a transaction and its final execution. Like PRIIPs, this has led to some firms disclosing negative transaction costs, which can lead to confusion.

Overall, the rules create the possibility that firms may disclose several different cost figures in different places, making it unclear which figures potential investors should be comparing. For example, it is possible under the rules that firms could disclose an “ongoing charges” figure in their KID; a different figure called “ongoing charges / total expense ratio” as the headline figure on their website; and a different “average annual charge” figure in the more detailed disclosures on their website.

PRIIPs requires firms to produce a range of performance scenarios to include in their KIDs. These are designed to show investors what will happen to the growth of their investment under four market conditions: favourable, moderate, unfavourable, and a stress scenario. The projections given by the scenarios are built by combining data on historic returns with a probability distribution2, in order to calculate how likely it would be for this historic return to continue in future. A limitation in this methodology is that while it is intended to be forward looking, it is in practice highly dependent upon past performance, and is driven by the historic returns the product has seen over its recommended holding period.

Given the strong performance of markets in recent years, the “moderate” performance scenarios in some funds’ KIDs predict returns of over 100% in a single year, or even higher returns over multiple years, using the methodology mandated by PRIIPs.

The industry has expressed concern that such figures may mislead investors. In response, the FCA has issued a statement in relation to PRIIPs. In its statement, it acknowledges that “for a minority of PRIIPs, the ‘performance scenario’ information required in the KID may appear too optimistic and so has the potential to mislead consumers”.

The FCA states “Where a PRIIP manufacturer is concerned that performance scenarios in their KID are too optimistic, such that they may mislead investors, we are comfortable with them providing explanatory materials to put the calculation in context and to set out their concerns for investors to consider”.

It adds that where firms selling or advising on PRIIPs have concerns that the “performance scenarios in a particular KID may mislead their clients, they should consider how to address this, for example by providing additional explanation as part of their communications with clients”. Notably, however, the FCA’s statement stops short of requiring firms to submit additional materials or consider whether they are needed.

PRIIPs and MiFID II rules now apply, but the thorny issue of costs and charges, together with comparability across products, endures and firms are increasingly asking regulators to review the requirements. There may be further guidance from national regulators and or European authorities in the near future to address some of the issues raised by firms.

Furthermore, the presentation of costs was flagged by the FCA as part of its Asset Management Market Study, published in June last year (for further details, see our blog), and it is considering possible remedies. Specifically, the FCA has said it is “testing ways to improve the effectiveness” of disclosures under MiFID II and PRIIPs to retail investors (for further information, see our blog on this topic).

In the meantime, and in the light of the FCA’s statement, it is open to firms to take additional steps to help investors navigate the new costs and charges figures available to them and so reduce the possibility of inaccurate interpretation. Such steps might include:

• Presenting all information on costs and charges in one easily accessible place, so that consumers do not need to hunt through different documents.
• Explaining how various cost and charges figures are calculated, why they may differ, and how they might be compared.
• Where firms consider a figure to be potentially misleading, explaining why they are required to produce it, and warning consumers about its limitations.