Future performance. How the European Commission stumbled on PRIIPs level 2 regulation.

With a press release of less than two weeks ago, we learn that the European Commission just tabled a proposal to delay of one year the application of PRIIPs legislation. Safeguard of investors’ interest as well as legal certainty for the industry appear to be the main reasons underpinning such decision.  After a heated summer of discussion on level 2 PRIIPs legislation, which saw the European Commission trying to surf a massive wave of opposition from the majority of industry representatives in order to meet the December deadline for application of the PRIIPs legislation, the one year extension now proposed has manifold implications.

Personally, the one year extension leaves me a little perplexed. At a point, especially after the workshop in Brussels of last july, I was sure that a delay would have been granted, same as I was sure of Trump winning the US elections (I should have followed my instincts and throw the kitchen sink at the bet I made on the result of the elections and not a few quid only, but that’s for another post). Without intending to contribute to a growing sentiment of Euroscepticism - as I love Europe and the Union believe it or not - I was amazed in seeing the relentless defence by the European Commission of level 2 legislation, which was otherwise so heavily chastised from all fronts. And with reason, if I am allowed.

The same press release from the European Commission contains once more one of the main arguments used to sustain the feasibility of application of PRIIPs legislation, irrespective of the implementation of level 2 RTS. The fact that given that PRIIPs legislation comes in the form of a regulation, per se enforceable and, in the view of the European Commission, also sufficiently clear not to necessarily need level 2 legislation, or at least not in the immediate term. This approach is debatable at best, in that from the very outset PRIIPs legislation was conceived under the Lamfalussy process and required for its completeness, accordingly, all the 4 layers of legislation. We are also talking about a very ambitious cross-sector legislative endeavour, benchmarked to MiFID in some of its aspects (which, by the way, was delayed of one year too in the application) and that required nearly 10 years in the making. If it took so long to get this gigantic piece of regulation near to completion, we can’t see why some more time, in order to get the fine tuning right, has to be seen as so outrageously inacceptable.

The Horizontal Approach

PRIIPs inception works can be traced back in 2007, when a first call of evidence was launched by the European commission. The purpose of that first step was to identify whether risks for investor protection could derive from the variety of inhomogeneous rules across Europe in the areas of product disclosure and distribution of different types of retail investment products. Since then, there has been a waltz of activities, workshops and papers produced, as it is required by the stakeholder consultation process underpinning the European legislative process.

The communication from the Commission on Packaged retail investment products dated April 2009 gives a high level indication of the aims and the scope of PRIIPs legislation. It is important to see how the Commission envisages PRIIPs legislation as initiative adopted to tackle two main areas – investor disclosures as well as selling practices – whose weakness was considered due to the patch work of inconsistent relevant regulations across Europe. Existing separate regulations – like the UCITS KID for the disclosures as well as MiFID for the selling practices – are also identified as benchmarks to adopt in the process of shaping such new legislative initiative. Also in the same communication, the Commission defines the horizontal approach to be adopted, which will manifest itself in horizontal rules for the creation of both key disclosures as well as selling rules for the products concerned. The expected outcome is an instrument that integrates or replaces the existing sectoral provisions and will also extend to products not covered so far.      

Future Performance, Tailoring and Consumer Testing

One of the main criticism raised on PRIIPs level 2 legislation pertains to the use of future performance scenarios in PRIIPs KIDs as opposed to indication of past performance. The fact that future performance scenarios may well mislead investors, defying the main purpose of the whole legislation, prompted the Economic and Monetary Committee of the European parliament – allegedly for the very first time in the history of European legislation on financial services - to veto the approval of the RTS.

However, believe it or not, PRIIPs was not conceived from the outset to obliterate past performance.  In fact, we have evidence of this in a working document of the European Commission, released in 2010 as a further consultation step on the legislative process, where, when talking about contents of the KID and the rules to be developed at level 1 legislation, it is clearly stated that disclosure of information should comprise past performance of the product, if a track record existed, or possible performance scenarios, if those were relevant. The same duality of approach still exist in the July 2012 proposal of regulation made by the European Commission, where the indication of information on how the product has done in the past is still separate from projections of possible future outcomes of the holding of the product and the latter seem to be relevant only for pension products according to the text of the proposal.     

When going through the vast amount of papers produced so far in the PRIIPs saga two other fundamental principles to the entire architecture emerge: a) the tailoring of the principles, so that the horizontal instrument could adapt to a variety of products; as well as b) the testing by consumers in order to ensure that the gap of comprehension of these products could be effectively bridged.

On this last point, a consumer testing initiative was carried out in 2015.  One of the main take away messages of the survey was that consumers are more familiar with future performance scenarios, rather than past performance. On this basis and in our view due to the growing misconception that homogeneous has to mean exclusive, the PRIIPs level 2 legislation wiped out the dual approach past performance/future scenario and concluded that the outcome of the consumer testing was to prevail. No more tailoring, only one size to fit all.

Closing Remarks

We all know that past performance, per se not an indicator of future results, is not necessarily welcomed across the industry. I just also read elsewhere rumours about the PRIIPs initiative potentially having lent itself as a correctional initiative to get rid of past performance once and for all. Not that we believe in all this or we find it something interesting to speculate on, but it is still something out there…  

Revised version of level 2 PRIIPs legislation is expected sometime at the end of Q2 2017, leaving sufficient time to industry participant to adapt to new rules, which we hope more in line with the principle of tailoring.

Stay tuned for more.

______________________________________________________________________Attilio Veneziano is the founder of Veneziano & Partners Ltd, a London and New York based regulatory boutique offering strategic advice on European financial services regulation to fund managers and other financial institutions. attilio@venezianoandpartners.co.uk