Insurance regulators blamed for Priips delay

Europe's national insurance regulators have been blamed for holding up approval of sweeping reforms of the European structured products market. A number of the watchdogs were reportedly unhappy with the final draft of the rules, with several abstaining from voting on them last week, according to sources close to the matter.

Regulatory technical standards (RTSs) for the Packaged Retail and Insurance-based Investment Products (Priips) framework, which is aimed at reforming disclosure practices for retail structured products, were formally approved by the European Supervisory Authorities (ESAs) on Wednesday April 6 – six days after an EU-imposed deadline.

It is understood that members of the European Insurance and Occupational Pensions Authority (Eiopa) – one of the three ESAs, which is made up of national-level regulators – delayed approval of the final text because of the insurance industry's concerns.

"Insurance supervisors were against the text as a whole, especially the use of a quantitative method for measuring the risk of insurance products and the requirement to disclose biometric costs in the cost indicator. [We thought] these questions were settled months ago, but members of Eiopa considered them still on the table," says a senior structured products pricing engineer familiar with the matter.

Eiopa finally validated the RTSs on April 6 via a qualified majority vote. It is understood that supervisors from several countries abstained in the final vote, including the representatives from Belgium. Eiopa declined to comment on the matter.

The RTSs determine the content and design of new key information documents (KIDs) that must be issued to all retail Priips customers once the regulation comes into force. A KID is a three-page document that outlines the risks and costs of a Priip, as well as performance scenarios showing its likely returns in unfavourable, moderate and favourable market conditions.

Insurance supervisors were against the text as a whole, especially the use of a quantitative method for measuring the risk of insurance products
A senior structured products pricing engineer

Following their publication, Insurance Europe – a trade body – blasted the RTSs as "inappropriate for insurance-based investment products" and claimed the resultant KIDs would relay misleading information about them to customers.

The industry's main bugbear is the rules' insistence that the premiums paid by customers for the insurance cover offered by many insurer-issued Priips be counted as a cost, and disclosed as such in the KID. Insurance Europe has long argued that these should be exempt, as other Priips do not offer the same protection from so-called biometric risks - such as risk of death or disability suffered by the holder.

Bank issuers were similarly unsuccessful in having the hedging costs associated with their products reversed out of the cost indicator, despite an intensive lobbying effort.

Risk indicator

Some changes to the final RTSs did win industry approval, however. Chief among them is the ESAs' decision to alter the parameters of the summary risk indicator (SRI).

Each Priip is assigned a market risk measure class of between one and seven. The higher the annualised volatility of a product, the higher the class assigned to it.

Stakeholders complained that the parameters of each class as laid out in the November draft were biased against equity-linked investments. For example, all products with an annualised volatility of 25% or above were assigned class seven on the scale, which the European Structured Investment Products Association (Eusipa) and the German Derivatives Association (DDV) claimed was too conservative and would capture many equity-linked products that were not high risk. 

David Stuff, Cube Investing

The final RTSs rejig the parameters. Products with annualised volatility of 20–30% will now be assigned to class five, and only those with 80% or above will be lumped in with the most risky score.

"Many market participants commented on the volatility scale and said it must be improved to properly capture leveraged products like warrants. The DDV made a proposal, and the ESAs settled on something not identical but close to it, acknowledging that with leveraged products in the scope of Priips you must have this kind of scale in order to truly discriminate between structures," says the senior structured products pricing engineer.

Product distributors, however, say the fine print on the market risk measure is riddled with ambiguities.

"We are confused about how to apply the volatility calculation to autocallables," says David Stuff, chief executive of Cube Investing in London. "Part 17 of Annex II [of the RTSs] defines the [value at risk] equivalent volatility of category three Priips using a formula incorporating the recommended holding period of the Priip or the period to the early maturity date. But if you have a product that could knock out in years one, two or three, what period of volatility are you calculating?"

The ESAs were unavailable to provide comment on the application of the market risk measure by press time.

Prescriptive performance scenarios

The section of the rules concerning performance scenarios was also reviewed. The final draft prescribes in painstaking detail how Priips manufacturers are to define the unfavourable, moderate and favourable scenarios, alongside an additional extreme downside scenario, and present them in the KID.

Mathias Strasser, chief executive of WallStreetDocs, a documentation advisory specialist based in London, says that from a KID-production perspective, the rules on performance scenarios represent "the biggest change" in the RTSs, but added these should ultimately help the end-customer.

"Investors want clear comparability between products and the more prescriptive the performance scenarios are, the more comparable they are," he says.

Nicola Higgs, London-based partner in the regulatory group at law firm Ashurst, also says Priips manufacturers should welcome the heightened level of prescriptiveness.

"The fundamental concern for them is the liability of getting the KID wrong. If they have discretion to design the performance scenarios, there is always the risk a regulator will look at a KID and say: this is not what we intended to see happen," she adds. The new rules should prevent this situation arising, she says.

The final RTSs now await formal validation by the European Commission before becoming an effective part of the Priips framework. It is hoped the commission will move quickly to achieve sign-off, as the implementation date of the regulation remains December 31 of this year.

"The European Commission started to validate part of the text while it was still being drafted, so I suspect it will be approved soon," says the senior structured products pricing engineer.