PRIIPs KIDs ‘What is this product?’ – what do the ESAs expect to see?

On 9 May 2022, the European Supervisory Authorities (ESAs) jointly published a Supervisory Statement, in which they set out their expectations regarding the 'What is this product?' section of the PRIIPs KID.

Overview

The aim of the Supervisory Statement (which is addressed to the EU NCAs) is to "achieve a high, effective and consistent level of regulation and national supervision promoting a level playing field and the protection of retail investors".

The ESAs note that different approaches are being taken by certain PRIIP manufacturers to describe the main features of the product and that some of these approaches go against the aims of the KID to provide retail investors with information that is accurate, fair, clear and not misleading.

Some of the key issues which the Supervisory Statement flag include:

• the use of the same general categories when specifying different product types

• overly generic language as a result of automation in creating text

• insufficient clarity in descriptions of capital protection and potential losses

• insufficiently clear, precise and direct descriptions of autocallability or early termination features

• a lack of clarity regarding the timing and frequency of coupon payments

• insufficient or very limited descriptions of the PRIIP's underlying assets

• insufficiently clear descriptions of the leverage factor and

• inadequate information in respect of the "intended retail investor".

As a result, the ESAs consider it important to clarify what their expectations are in respect of the section of the KID entitled 'What is this product?'

For each issue identified, then, the Supervisory Statement provides

• a description of some poor practices observed (with an Annex which includes specific examples which the ESAs have seen in practice) and

• the ESAs' expectations as to how the clarity and comparability of KIDs can be improved.

The KID section "What is this product?"

The 'What is this product?' section, the first descriptive section of the KID, plays an essential role in enabling retail investors to understand the key features of the product.

The answer to the question 'What is this product?' must be provided according to five elements:

• the type of PRIIP (Type)

• its objectives and the means for achieving them, including by means of direct or indirect exposure to the underlying assets (Objectives)

• the description of the type of retail investor to whom the PRIIP is intended to be marketed (Intended retail investor)

• details of the insurance benefits (where applicable)

• the PRIIP's term (Term)

The section is largely "free text" within the KID template and it is the responsibility of the PRIIP manufacturer to use appropriate text and language, rather than pre-defined narrative explanations.

What guidance do the ESAs give?

Looking at the ESAs' comments on the different elements referred to above:

(a)   Type

This part of the KID is intended to describe the PRIIP's legal form. However, the ESAs have a number of concerns regarding current practices. In particular, the use of the same general legal category or type for different products can mean that the Type section is of limited value to retail investors in distinguishing between products.

The ESAs expect PRIIP manufacturers to:

• present the class of product in a way that is short, concise and easy to understand

• avoid long narratives on the details of the specific product

• choose the legal terminology that best represents the nature of the product and specify this further as far as possible

• include in the description:

  • an indication (where applicable) that the product's return depends on the performance of an underlying asset(s) / reference value(s)

  • clarification that the retail investor may still lose the entire capital (e.g., in the case of insolvency of the PRIIP manufacturer).

(b)   Objectives and Term

The ESAs make the following points

i) Clear language and layout - usefulness for the retail investor

The language used in the KID is frequently too technical and difficult to understand, with PRIIP manufacturers using very long and complex legal descriptions that retail investors find hard to understand.

A KID should be written in a language that is easy to understand for the intended type of retail investor and PRIIP manufacturers should consider how to structure the text so that it is easy to read, avoiding long complex sentences and paragraphs, without distinction between the different components of the product.

ii) Automated process to prepare the KID resulting in too generic information

The Supervisory Statement notes that descriptions in the KID can be too generic, which the ESAs see as a consequence of automating production of the content of this section. This can lead to the situation where a KID contains a generic description of how the product works in very technical and legal language, perhaps followed by a table containing all the relevant dates for the product and a variety of other details. This makes reading and understanding KIDs very difficult.

At the same time, though, NCAs have observed that other documents prepared by the PRIIP manufacturer (such as marketing brochures) in which features are detailed using a bespoke text for each product, achieve a much higher level of quality.

The ESAs consider that any automation in the KID preparation process "should not impair the use of clear, succinct and comprehensible language within the KID" and that quality checks should be used to ensure the clarity and accuracy of the drafting.

iii) Description of capital protection and potential losses

The ESAs consider that the relevant description contained in the KID should be sufficiently clear, precise and direct in specifying that, in given circumstances, the product implies a capital loss.

More specifically:

a.    adverse scenarios that imply a capital loss should be clearly identified and should explicitly indicate the possibility of such a loss

b.    the ESAs do not consider the practice of only showing the formula used to calculate the payoff to be fair, clear and not misleading.

iv) Autocallability and early termination due to extreme market events

The description included in the KID for financial products which have either autocallability or early termination features is often insufficiently clear, precise and direct.

The ESAs consider that

• either a pure narrative description or a mix between text and tables, provided in clear and easy to read language is an appropriate way of providing information

• an early redemption feature should be shown both prominently within the 'What is this product?' section, (possibly at the very beginning of the description of 'Objectives') and also in relation to the information on the PRIIP's 'Term'

• PRIIP manufacturers should try to include the most relevant concrete data/levels in the text, in particular the barrier levels and the frequency of autocall windows.

v) Coupon payments

The ESAs have observed a number of different approaches to explaining the timing and frequency of coupon payments - see, for example, Examples 8 to 10 in the Annex to the Supervisory Statement.

The ESAs consider that the appropriate ways of providing this information are either

• a pure narrative description or

• a mix between text and tables

provided in all cases a clear and easy to read language is used.

PRIIP manufacturers should, as appropriate, try to include in the text the most relevant concrete data/levels for the product with indicating full details on observation dates and calculation of initial/final values in a separate table if needed.

vi) Lack of information about the underlying assets

Information about the PRIIP's underlying assets is "sometimes insufficient or very limited: in many cases, only the name of the reference asset is provided" - particularly important for products where the underlying is a custom index.

PRIIP manufacturers should try to describe - clearly and accurately - the specific nature (share, bond, commodity, index, etc.) and business sector of the underlying assets or reference values, so retail investors can evaluate the aim of the product and identify the drivers of its performance.

vii) Description of leverage factor

Several examples were seen where a KIDs fails to provide enough information about the relationship between the payoff of the product and the underlying asset and about the dynamic or constant nature of the leverage factor.

So that retail investors can better understand the payoff of those products, the functioning of the leverage factors and the risks related to them, the ESAs recommend that the following are clarified as part of the 'Objectives':

a.    the type of leverage effect (constant or dynamic)

b.    the value that the leverage effect can assume

c.    an indication that the leverage effect can reach very high levels

d.    with particular reference to CFDs, the fact that the retail investor may be required to increase the margin due to market changes and that his/her position may be closed early if the margin call is not fulfilled.

(c)  Intended Retail Investor

The Supervisory Statement recommends that the PRIIP manufacturer should describe the target retail investors identified "in a concise and clear manner", which is product-specific and avoids generic or unclear expressions should be avoided.

The description should cover all the aspects set out in Article 2(3) of the PRIIPs Delegated Regulation, including the ability of retail investors to bear investment loss and their investment horizon preferences.

Labels or categories used in the KID terms should be clear and understandable by the target retail investor type and briefly explained where applicable.

In particular, the ESAs note that:

a.    a more specific timeframe (e.g., 'very short', 'short', 'medium' or 'long') should be used for the intended investment horizon rather than a generic sentence such as 'clients must be able to keep the product until the maturity'

b.    to improve readability, when mentioning the summary risk indicator, the KID could show the concrete level rather than using a generic sentence applicable to all products, such as 'investors shall be able to bear the risk implied in the summary risk indicator'

c.    when the description of the intended retail investor's loss bearing capacity takes into account the credit risk or risk of default as well as the market risk, this should be indicated clearly to ensure coherence with other information in the KID (for example, the level of the summary risk indicator or regarding any capital protection / guarantee).