European supervisors may step in over Priips confusion

Differences in how issuers disclose product costs harming comparability, observers say

Fears that comparability is being undermined by inconsistency in how costs are calculated

European authorities are weighing up extra guidance on rules governing the sale of structured products to investors in Europe, amid concerns that the existing regulation is being interpreted inconsistently by issuers.

Under new Priips legislation for packaged retail and insurance-based investment products, issuers must provide a simple breakdown of the risks and costs of each product, to enable buyers to easily compare performance across investments. But issuers are using different methods to calculate the cost to buyers, undermining any attempts to achieve comparability.

In a statement to Risk.net the European Securities and Markets Authority said: “While cost calculations are specified in the Priips delegated act and ensure comparability among products, [European authorities] are currently looking into these issues and would issue any guidance, if needed.”

The Priips regulation, which came into force across Europe on January 1, 2018, specifies the types of costs to be included in the key information document, or Kid, accompanying each product. But critics say the regulation does not give sufficient detail regarding how the costs are presented to would-be buyers. For products that are active over a fixed or recommended time period, the calculation and presentation of costs is straightforward. The complication lies in products that have a variable or unpredictable maturity, such as autocallable products. Here, issuers are in a bind over whether to present the costs as yearly figures, or aggregated over a given time period.

“Unfortunately there is very little consistency across issuers,” says a senior structured products trader at one private bank. “They do not appear to be using the same approach or calculation. As a result the numbers are not meaningful at this stage. I am hoping it starts to improve as the industry gets used to it.”

A senior structurer at a European bank illustrates a potential source of confusion over cost disclosure in autocallables, a type of structured product that returns the principal and a coupon to the investor ahead of maturity if the underlying breaches a pre-set barrier.

He uses the example of a 10-year product that incurs a charge of 500 basis points. The issuer may present the yearly cost in the Kid as 50bp per year. But if the product is autocalled early, say at two years, it would be misleading to infer the total costs as 100bp, or 50bp multiplied by two years, when in reality the total yearly cost was 250bp, ie the 500bp full-term cost divided by two years.

“The numbers don’t add up – it’s not how you would expect,” says one structured products distributer. “For example, if you are looking at two of exactly the same products, one bank which is offering a more competitive payoff can also show higher costs and charges on the product than the other bank. The difference between the upfront costs can be quite significant.”

Unfortunately there is very little consistency across issuers. They do not appear to be using the same approach or calculation

Senior structured products trader at a private bank

Annex VI of the Priips regulation lays out the types of costs the issuer or distributor should include in cost calculations. The costs fall into three broad categories: one-off, recurring, and incidental. Within each category, different types of charges are listed. For example, when calculating one-off entry costs and charges, the regulation says the figure should include: “sales commissions, structuring costs, hedging costs, legal fees, costs for capital guarantee, and implicit premium paid to the issuer”. Similar detail is given for the other categories.

Where the regulation is less detailed is in the presentation of the costs over time. The Kid document offers a one-size-fits-all template detailing cost estimations at three time intervals and the impact on investors’ return, set as percentages.

The guidance does not seem to make allowances for the nuances of different investment types, and how their costs are presented; whether the issuer details the full cost of carrying the instrument or presents the cost per annum calculated on assumptions about the term of the product.

“The charges are the charges – you have got hedge costs, margin etc. So they are in there; it is a question of how you show the impact of those on the carrying cost of the instrument,” says the European bank’s structurer. “We disclose the full cost, other banks choose the per annum cost assuming that the instrument runs to term, which if it doesn’t they are underestimating the impact of the charges.”

Overshadowed by Mifid

Several market participants hold the view that Priips has suffered from being released just days before its more wide-ranging cousin, Mifid II, which covers the gamut of investment products sold across Europe. 

“I think that is a right observation because everyone is focusing on Mifid so Priips tends to be forgotten in a way,” says Pim Rank, solicitor at Dutch firm NautaDutilh, based in Amsterdam.

But while market participants are fretting over inconsistencies in the Kids, a director of structured products at a European wealth management firm fears the consequence of yet more regulation from European authorities keen to iron out any wrinkles in the rules.

“It is more about taking a step back and having a look at what’s there. Perhaps authorities should let the market settle for a while, say 12 months, and after that review what’s done. Maybe there will be a need to replace some of the existing rules with clearer regulation, or maybe there will be places to take a few steps back as opposed to taking a few steps forward,” he says.