LPA

Category: Regulation

  • ESMA Proposes Key Changes to Settlement Discipline Framework to Support T+1 Transition

    ESMA Proposes Key Changes to Settlement Discipline Framework to Support T+1 Transition

    13 October 2025 – The European Securities and Markets Authority (ESMA) has issued its final report recommending significant amendments to the Regulatory Technical Standards (RTS) on Settlement Discipline.

    The proposed revisions aim to improve settlement efficiency across the EU, facilitate the shift to a T+1 settlement cycle by October 2027, and ease the operational burden on central securities depositories (CSDs) and market participants.

    Key measures include:
    • Same-day timing for trade allocations and settlement instructions,
    • Machine-readable formats for allocations and confirmations,
    • Mandatory functionalities such as hold and release, auto-partial settlement, and auto-collateralisation,
    • Enhanced monitoring and reporting of settlement fails,
    • A phased implementation starting in December 2026.

    The draft amendments have been submitted to the European Commission, which has three months to decide on their adoption. ESMA urges market participants to integrate these changes into their T+1 transition strategies.

    Source: European Securities and Markets Authority (ESMA), Final Report on Settlement Discipline RTS Amendments, 13 October 2025.

  • EFAMA Regulatory Recap Week 9/2025: New ESG Rating Regulations and Fund Consolidation in Focus

    EFAMA Regulatory Recap Week 9/2025: New ESG Rating Regulations and Fund Consolidation in Focus

    The European Fund and Asset Management Association (EFAMA) has announced significant regulatory developments this week, with far-reaching implications for the European asset management industry. Two key topics were at the forefront:


    1. New ESG Rating Regulations – Enhanced Transparency and Oversight
    The European Parliament has passed new ESG rating regulations, introducing stricter oversight of ESG rating providers. These measures aim to enhance transparency in sustainability assessments and combat greenwashing. EFAMA welcomes this move but advocates for even broader regulation of all ESG data products.


    ➡ Key Takeaways:


    ESG rating providers will now need authorisation from ESMA (European Securities and Markets Authority).
    The new regulations strengthen trust in ESG investments and improve the comparability of sustainability assessments.
    EFAMA calls for further regulation to ensure the long-term integrity of the ESG sector.


    2. Fund Consolidation Alone Is Not Enough – EFAMA Proposes Alternative Strategy
    In its latest Market Insights publication, EFAMA questions whether mere fund consolidation in Europe effectively reduces costs. Instead, the association suggests that asset managers should focus on larger fund volumes to better leverage economies of scale.


    ➡ Key Findings:


    A comparison with the US reveals that larger fund volumes, rather than consolidation, achieve more effective cost reductions.
    Economies of scale could help European asset managers remain competitive and alleviate margin pressures.
    The debate over more efficient fund structuring is likely to gain further traction in the coming months.


    LPA Insight: Navigating Regulatory Challenges with the Right Technologies


    These latest developments highlight the increasing importance of RegTech solutions and innovative digital compliance tools for asset managers. As a leading provider of technology solutions for asset and wealth management, LPA Lucht Probst Associates supports financial institutions in efficiently meeting regulatory requirements:


    🔹 Automated ESG Reporting Solutions – Seamless integration into existing processes to comply with new ESG regulations.
    🔹 Digital Fund Structure Analysis – Optimisation of fund strategies through data-driven models.
    🔹 Regulatory Compliance Platforms – Efficient management of policies to ensure adherence to European regulations.


    ➡ Want to learn more? Contact us for bespoke solutions in RegTech & Asset Management.


    These developments underscore the increasing regulatory challenges facing asset managers in Europe. Companies that proactively adopt digital solutions can not only minimise compliance risks but also significantly enhance their operational efficiency and competitiveness.

    📢 Stay informed – Subscribe to LPA News for the latest market updates!
     

  • EBA Endorses European Commission’s Amendments on Conflicts of Interest for Asset-Referenced Tokens

    EBA Endorses European Commission’s Amendments on Conflicts of Interest for Asset-Referenced Tokens

    The European Banking Authority (EBA) has endorsed the European Commission’s substantive amendments to the final draft of the Regulatory Technical Standards (RTS) on conflicts of interest for issuers of asset-referenced tokens. The EBA accepts the Commission’s changes, assuming that risk alignment mechanisms will be included in the final version. A key amendment narrows the definition of “personal transactions” to enhance proportionality, excluding shareholders or members from the scope. The European Commission further restricted this scope by removing additional connected persons, aligning the focus on management bodies and employees. Another major change refines the application of RTS provisions to specific connected persons and clarifies relevant contractual arrangements. The Commission also removed references to risk alignment mechanisms for variable remuneration, but agreed to reinstate them following discussions with the EBA. Additionally, the detailed reporting obligations for conflict of interest management were replaced with a high-level requirement. The EBA acknowledges these modifications as substantive but finds them acceptable for proportionality reasons. Non-substantive changes include structural and wording adjustments to improve clarity and legal coherence.

  • European PRIIP Regulation Set for Major Overhaul: A Glimpse into the Proposed Changes

    European PRIIP Regulation Set for Major Overhaul: A Glimpse into the Proposed Changes

    State of Play as of November 2023

    Significant changes are currently under discussion by the National Competent Authorities (NCAs) with regards to PRIIPs. These amendments are a part of the Retail Investment Strategy (RIS), which is designed to enhance the long-term savings of European Union citizens and their engagement in capital markets. The RIS is characterized as an “omnibus directive”, which means it is not a standalone directive but instead amends several other directives, including MiFID II, IDD, UCITS, AIFMD, Solvency II, and PRIIPs.

    The discussions are primarily centered on Level 1, while the nomination of the European Supervisory Authorities (ESAs) is in progress for the drafting of Level 2 Regulatory Technical Specifications (RTS) once the Level 1 amendments have been agreed upon and approved. As a result, the implementation of these amendments is expected to be at least two years away, with the exception of a few Level 1 changes highlighted below. These do not require Level 2 text and are expected to enter into force immediately after the entry of Level 1 into the Official Journal.

    In this article, we will delve into the main draft amendments. While the ones outlined below are not an exhaustive list, we believe they represent the most significant changes. Minor wording corrections have been omitted from our discussion.

    Digital KID

    To bring the PRIIP KID up to date with contemporary needs, the adoption of an electronic format is recommended. This format is defined as any durable medium other than paper. The digital KID is proposed to be the default version provided to investors, while the distributor should inform the retail investor of the option to request a paper KID free of charge. In other words, manufacturers will retain the obligation to produce KIDs in the traditional paper document format, in addition to generating the electronic format.

    Layered Format

    The digital KID is suggested to adopt a “layered” format. This entails presenting high-level information as the initial step and allowing investors to gradually explore further information based on their interests.

    The concept of a layered format has previously been introduced by EIOPA in the Pan European Pension Product (PEPP). For additional details on this concept, please visit EIOPA’s website: EIOPA PEPP. To provide a more concrete understanding, you can also examine an illustrative PEPP KID mockup created by BETTER FINANCE, which includes elements such as (1) a dashboard, (2) high-level topics that can be expanded, (3) brief term definitions, and (4) featured warnings and disclaimers: PEPP KID Mockup.

    Accessibility Features

    In alignment with the European Accessibility Act, it is anticipated that the digital KID will need to incorporate accessibility features to facilitate reading for individuals with disabilities. For more information about the European Accessibility Act, please refer to: European Accessibility Act.

    Additional Requirements

    The draft amendments also set two additional requirements for the digital KID:

    1. Allow change of holding periods
    2. Allow comparison between PRIIPs

    While there is limited detailed information available on these requirements, it is explained that allowing the change of holding periods could prove valuable in simulating costs for different time horizons.

    It is crucial to emphasize that, under the current PRIIPs cost calculation methodology, there are significant challenges associated with implementing this requirement. Costs for holding periods longer than one year are currently based on the Moderate Scenario. However, like most scenarios, the Moderate Scenario can vary depending on the holding period. As a result, the following issues are identified:

    1. Misleading cost change:
    The primary aim of illustrating costs for different holding periods is to assess the actual costs that would be incurred due to their nature, whether they are charged as one-off fees, upon entry or exit, or on an ongoing basis. However, part of the cost change resulting from selecting a different holding period may stem from a different Moderate Scenario rather than changes in the cost logic or timing. Explaining this to retail investors could prove challenging.

    2. Technical challenge:
    To accommodate an ad-hoc change of the holding period for cost calculations exceeding one year, manufacturers would need to either (1) calculate the Moderate Scenario for all possible holding periods in advance, which could lead to longer processing times than the already lengthy process in place today, or (2) allow for ad-hoc calculation and the generation of KIDs, which presents a technical challenge.

    Maintaining Comparability vs. Enhancing Comprehensibility

    One of the fundamental principles of the existing PRIIP KID framework is comparability. This principle aims to enable investors to make comparisons of risk, performance scenarios, and costs among different PRIIPs. Consequently, content that is specific to particular assets, i.e. applicable only to a subset of PRIIPs, has been excluded from the PRIIP KID.

    An illustrative example of such content is the past performance data for funds. While this information is included in UCITS KIIDs and has proven highly beneficial to investors, it did not become an integral part of the PRIIP KID due to the emphasis on comparability. Instead, manufacturers are mandated to create a separate webpage or document for presenting past performance information and include a link within the “Other Relevant Information” section of the PRIIP KID.

    One of the draft amendments suggests shifting the balance towards comprehensibility over strict comparability. In other words, it is proposed to allow the inclusion of asset-specific content if it contributes to investors’ understanding. This change would permit the inclusion of past performance data for funds within the PRIIP KID, along with other asset-specific content.

    New Section “How environmentally sustainable is this product?”

    Another proposed amendment suggests a shift in the presentation of the product’s environmental sustainability in the PRIIP KID. Rather than including it in the “What is this product?” section, there should be a dedicated segment specifically outlining the environmental sustainability aspects of the PRIIP. While the precise location is not explicitly specified, from the location of this amendment within the directive, it appears that this section could follow the RHP section (“How long should I hold it, and can I take my money out early?”) and precede the “How can I complain?” section within the KID.

    Currently, it seems this sustainability section will be required for products aligned with SFDR Article 8 and Article 9. It should include the product’s minimum proportion of environmentally sustainable investments, its expected GHG emission intensity and a link to the product’s pre-contractual SFDR disclosure. The content of this section is expected to be further developed by the European Supervisory Authorities (ESAs) as part of Level 2 Regulatory Technical Standards (RTS).

    It’s worth mentioning a noteworthy suggestion put forward by Germany’s Sustainable Finance-“Beirat”, proposing the inclusion of an ESG scale ranging from A (indicating the strongest consideration of sustainability preferences) to F (signifying no explicit consideration of sustainability preferences). This suggestion has been tested among both investment advisors and retail investors and has received positive feedback for its simplicity and comparability.

    Incidentally, a previously proposed section called “Product at a Glance” was introduced in an earlier version of the draft amendments. This section was designed to provide a snapshot of the PRIIP, including its type, SRI (Sustainable and Responsible Investment) aspects, total costs, RHP, and insurance benefits (if applicable). However, during discussions, National Competent Authorities (NCAs) argued that this new section included redundant information. Furthermore, it was emphasized that the entire KID serves as a summary document presenting only “key information,” leading to the removal of this particular draft amendment.

    MOPs with Numerous Underlying Investment Options

    This particular draft amendment holds relevance primarily for insurance-based investment products (IBIPs). If you are not dealing with IBIPs, you may proceed to the next draft amendment.

    Most often, these IBIPs are Unit Linked products that offer investors the flexibility to select from a range of underlying investment options, encompassing funds, structured products, and various other investment choices. The existing PRIIPs Regulatory Technical Standards (RTS) present two distinct approaches for Multi-Option Products (MOPs) associated with IBIPs:

    Article 10(a): Preparing a Key Information Document (KID) for each combination of the insurance wrapper and underlying investment option.

    Article 10(b): Generating a Generic KID featuring risk and cost ranges at the insurance wrapper level, accompanied by a Specific Information Document (SID) for each underlying investment option, detailing its risk, performance scenarios, and costs. The cost ranges presented in the Generic KID should amalgamate the expenses associated with the insurance wrapper and the underlying investment option.

    In certain cases, MOPs permit investments in a multitude of underlying options, where investors may acquire numerous equity shares, corporate bonds, and government bonds within the insurance wrapper. However, implementing Article 10(a) or Article 10(b) for such PRIIPs presents significant challenges:

    1. Article 10(a): Drafting a KID for each combination of the insurance wrapper and underlying investment option necessitates the manufacturer to calculate Summary Risk Indicator (SRI) and performance scenarios for tens of thousands of underlying investment options. Calculating performance scenarios involves utilizing a 10-year price history, and for any share or bond lacking this requisite price history, the manufacturer must undertake the laborious task of history completion.
    2. Article 10(b): Determining cost impacts, named Reduction in Yield (RIY) in PRIIPs RTS version 1, necessitates to calculation of the Moderate Scenario for holding periods exceeding one year. Similar to Article 10(a), calculating the Moderate Scenario for each underlying investment option entails disproportionate efforts, including compiling a 10-year price history and calculating the Moderate Scenario for tens of thousands of underlying investment options.

    Apart from the technical complexities, the inclusion of numerous underlying investment options results in extensive risk and cost ranges within Generic KIDs, casting doubts on their practicality for investors.

    To address these formidable challenges, a proposed draft amendment suggests allowing Generic KIDs to encompass solely the costs associated with the insurance wrapper, provided that:

    • The manufacturer provides the investors with an interactive tool allowing them to research and compare underlying investment options, including their costs and, where available and comparable, risks and performance;
    • The investors have easy access to the pre-contractual information relating to the underlying investment options;
    • The manufacturer provides investors with comprehensive cost information related to an investment option if requested by an investor.

    Nevertheless, several questions and concerns have been raised by National Competent Authorities (NCAs) regarding the interactive tool, and further deliberation on this draft amendment is anticipated.

    When should the KID be handed to the client?

    One area of concern relates to the timing of KID distribution to clients. During their mystery shopping exercises, the European Supervisory Authorities (ESAs) identified instances where the PRIIP KID was handed over to investors at the conclusion of the sales process, mere minutes before investors subscribed to a new product.

    A proposed draft amendment seeks to provide clarity by stipulating that the PRIIP KID should be furnished by distributors to retail investors concurrently with other marketing materials, such as product brochures, factsheets, and the like.

    In light of this requirement, manufacturers should also consider situations where the indicative terms of a product at the outset of a subscription period may differ from the final terms of the product.

    KID Review and Update

    The existing Regulatory Technical Standards (RTS) employ wording like “where it remains available to retail investors” (RTS Article 15). This phrasing has led to ambiguity in cases where it is unclear whether a KID should be monitored and revised (in the event of a “significant change” or every 12 months). Such cases include:

    1. Closed-end funds: Following the initial launch and capital raising phase, closed-end funds enter a second stage where investments are deployed, and investors await returns. During this phase, if an existing investor wishes to exit and new investors need to be located to purchase the investment, it’s uncertain whether a PRIIP KID is required and whether it qualifies as being “available to retail investors.”
    2. Run-off regular premium products: In the context of regular premium products, if a product is closed to new investors, and new investments are solely made through premium payments from existing investors, it’s unclear whether the product is still considered “available to retail investors.”

    The draft amendments are expected to clarify these scenarios and determine whether KIDs should be monitored and updated in these cases.

    Comprehension Alert

    The draft amendments propose the elimination of the comprehension alert for complex products, citing two key reasons:

    • It has not demonstrated effectiveness in alerting retail investors to the potential risks associated with particularly complex products.
    • It inadvertently dissuades retail investors from considering less complex investment products.

    In the event of approval, this amendment will come into effect immediately upon the publication of Level 1 in the Official Journal, as it does not necessitate a Level 2 specification.

    The National Competent Authorities (NCAs) are currently engaged in discussions regarding this suggestion, with several potential outcomes under consideration. These range from complete removal, partial removal, adjustments to the alert’s narrative, replacement with alternative narratives, to retaining the alert in its current form.

    Exclusions from PRIIPs scope

    Several amendments propose the exclusion of certain products and features from the purview of PRIIPs:

    1. Immediate annuities: An immediate annuity is a financial product that involves a single lump-sum investment, providing ongoing income either for a specified duration or for the investor’s lifetime in return. A draft amendment seeks to clarify that immediate annuities do not fall within the scope of PRIIPs.
    2. Make-whole clause: Many corporate bonds incorporate a “make-whole clause” that allows the bond issuer to prepay the remaining debt early, based on a predefined formula. In a prior supervisory statement issued in October 2019 (available at ESMA – Supervisory Statement), it was clarified that if “the mechanism to calculate the discount rate is known in advance to the retail investor,” this clause would not render the product a PRIIP. Given the debatable legal binding status of a supervisory statement and the inherent ambiguity in the described scenario, the draft amendments suggest that “make-whole clauses are outside the scope of the PRIIPs Regulation, provided they are redeemed at a fair value.”

    These amendments will come into effect immediately upon the publication of Level 1 in the Official Journal, as they do not require Level 2 specifications.

    Extension to 4-Page Limit

    At present, Level 1 regulations impose a constraint on the length of the PRIIP KID, limiting it to three A4 pages. However, with the incorporation of additional content, including the new sustainability section and asset-specific information (e.g., past performance), it becomes apparent that allowing for a longer document is necessary. Therefore, the draft amendments recommend extending the paper version of the PRIIP KID to four A4 pages.

    Summary

    With the new PRIIP Level 1 regulation on the horizon, the winds of change are becoming palpable, and they are undeniably significant. In a move not entirely unexpected, environmental considerations are making their way into PRIIPs, aligning with the growing emphasis on responsible investing.

    Furthermore, the introduction of more digital content and interactive presentations heralds a promising shift, although it necessitates a substantial IT effort to ensure broad accessibility to the digital Key Information Document (KID).

    While we continue to rely on PDFs as a reference point, the state of the update process reveals an interesting dynamic. Some National Competent Authorities (NCAs) have reached consensus on certain updates, while others remain under discussion, leaving room for potential major shifts in the coming years.

    In essence, this journey represents an opportunity to transform the KID into a more modern, useful, and interactive tool, a change that promises to be for the better. However, it’s a challenge that cannot be underestimated, especially given the usually tight deadlines. Rest assured, we are committed to steering through this challenge and diligently monitoring the evolving landscape.

    As we move forward, our commitment to keeping you informed about these transformative developments remains unwavering, and we stand ready to navigate this evolving landscape together.

    231106_PRIIP_StateOfPlayNov23.pdf

  • PRIIPs RTS v2: Concerns About Misleading Performance Scenarios

    PRIIPs RTS v2: Concerns About Misleading Performance Scenarios

    PRIIPs suffers lots of criticism around its methodology for Performance Scenarios. Both manufacturers and consumers claim the results are often too optimistic, since they are based on the last 5-year performances and these were positive. In an effort to solve these issues, the ESAs introduce in PRIIPs RTS v2 a new methodology for the calculation of the Favourable, Moderate and Unfavourable scenarios for most funds. Or more precisely, it applies to linear products, called Category 2 in PRIIPs terminology. The new methodology follows a back-testing approach over at least 10 years and the unfavourable scenario is based on the worst scenario found.

    Why should the new methodology lead to more balanced results?

    The longer period (10 years vs. RTS v1’s 5 years) is expected to “catch” additional samples, with a higher probability of some negative scenarios. In addition, while the unfavourable scenario in RTS v1 is based on the 10th percentile, in RTS v2 it is based on the worst scenario. Again, a higher probability for a negative result. Moreover, the methodology for the unfavourable scenario embeds a mechanism to catch further negative performances: the back-testing should take into consideration not only full holding periods, but also shorter periods during recent years (and extend them using “linear transformation” to the required holding period, that’s another topic for a different article). This technique further increases the chances to find negative unfavourable scenarios.

    Does the new methodology help?

    In many cases, it does. Unfavourable scenario will show negative results, illustrating the possibility of loss to the investors. However, still, under current market development over the last 10 years, there are many cases the new methodology will not help. And now, there is another concern: in many cases the new technique for the unfavourable scenario shows unrealistically over-pessimistic results. Let’s see some examples.

    Misleading positive unfavourable scenario for “mainstream” equity funds

    For a recommended holding period of 5 years (market practice for equities), many equity funds will show a positive return in the unfavourable scenario. Why? Since those funds (1) did not experience a loss in case of 5-year holding over the past 10 years, and (2) they did have negative returns for a minimum holding period of one year over the past 5 years to date. Note that one year is the minimum period in the technique of applying “linear transformation” on shorter periods, again, due to reading constraints that’s a topic for another article. For example, we calculated the unfavourable scenario for Invesco S&P 500 UCITS ETF (calculation date: 27.01.2022). For an investment of USD 10,000 it shows a value of USD 13,343 after 5 years. This translates to a positive annualized return of 5.94% in the unfavourable scenario (!), and we are talking of a fund tracking a popular, mainstream equity index. By the way, you might say no worries, RTS v2 allows us to choose lower percentiles from the calculated scenarios, if we believe the results are too optimistic. Well, you are wrong. This possibility exists only for the non-linear products (Category 1 & 3 in PRIIPs terminology) with the unfavourable scenario based on the 10th percentile. In the case of the back-testing methodology, the unfavourable scenario is based on the worst outcome. Sorry, there is no lower scenario.

    Misleading too negative unfavourable scenarios

    On the other hand, for funds that experienced a negative performance over the last year, the methodology assumes this negative performance will repeat, again and again. This is not happening in equity markets. Usually, after a period of one to two years, there is a recovery (and in many cases even before). As an example, we chose fund Xtrackers MSCI China UCITS ETF (calculation date: 27.01.2022) and calculated its unfavourable scenario. Since this fund experienced a loss of -33% over the last year, this translates into a compounding loss of -86.42% over 5 years. This never happened! Actually, the results lead to a lower return than the stress scenario that still follows the Cornish Fisher expansion-based methodology. In this case, according to RTS v2, the stress scenario needs to be adjusted: it should be capped at the unfavourable scenario level. This phenomenon happens with any fund experiencing a significant loss over the last year.

    Conclusion

    We know, finding a methodology that always works is difficult if not impossible. The new methodology for performance scenarios of funds has higher chances to eliminate overly optimistic results. However, as illustrated above, too-good results will still occur, while exaggerated pessimism in the unfavourable scenarios will become a common phenomenon.

  • Comparison between UCITS SRRI and PRIIPs SRI

    Comparison between UCITS SRRI and PRIIPs SRI

    Executive summary

    Towards the expiry of the UCITS exemption from PRIIPs, we decided to write an article pointing out practical changes and differences between the UCITS SRRI (the Synthetic Risk and Reward Indicator used in the directive on undertakings for collective investment in transferable securities) and the PRIIPs SRI (the Summary Risk Indicator as part of the packaged retail investment and insurance-based products regulation).

    Both operate on a 1-7 scale but have a completely different methodology. This has been a source of confusion amongst investors. As UCITS funds will be required to reclassify risk using the PRIIPs methodology, it is likely that the risk classification number of existing funds will become lower than previous.

    For example, as will be elaborated in this article:        

    • Many equity UCITS funds that are classified as SRRI 6 or 7 will be classified as SRI 5.
    • Many high yield fixed income UCITS funds that are classified as SRRI 4 or 5 will be classified as SRI 3.
    • Some investment grade fixed income UCITS funds that are classified as SRRI 3 will be classified as SRI 2.

    Good industry practice is that the fund managers should make clear to investors and sales distribution channels that the lower risk number does not represent a real reduction in risk but is merely the effect of a different risk calculation method. This lower risk level may also impact the product governance and target market decisions. The PRIIPs RTS does allow manufacturers to voluntarily increase risk classifications, but it is felt that this should only be done under an industry level alignment in order to maintain comparability between similar funds.   

    UCITS SRRI Calculation

    The synthetic risk and reward indicator is a requisite part of the Key Investor Information Document (KIID) for UCITS funds. The SRRI is used to indicate the level of risk of a UCITS fund by providing a number from 1 to 7, with 1 representing the lowest risk and 7 representing the highest.

    The SRRI is based on historical data of the fund prices. By calculating a standard deviation of the historical returns of the fund (i.e. realised/historical volatility) and then mapping it into seven buckets. This calculation is seen as very simplistic.  

    PRIIPs SRI Calculation

    The Summary Risk Indicator is composed of two measures; Market Risk Measure (MRM) and Credit Risk Measure (CRM). Most UCITS funds have the lowest CRM due to two reasons: (1) The fund assets are held in segregated accounts and in the case of the fund manager becoming insolvent, the fund assets are still held within those accounts on behalf of the investors. (2) The PRIIPs RTS requires to consider credit risk on a look-through basis only in case of an exposure of 10% of more of the fund’s value to a certain entity.

    When the CRM is the lowest (i.e. CRM 1), the SRI is affected only by the MRM, as illustrated in the following table (taken from the RTS, ANNEX II, PART 3, point 52):

    As shown in the table above, when the CRM is 1 (i.e. CR1, first row), the SRI (indicated in the table cells) equals the MRM. Therefore, for the sake of this article referring the most UCITs, we will focus on the MRM, assuming the CRM is 1.

    For most UCITS funds (linear exposure, i.e. PRIIPs Category 2), the formula used for calculating the PRIIPs MRM is the Cornish Fisher expansion formula. This statistical technique was first described in 1937 and helps to approximate the value at risk of an investment. The formula considers the historical returns of a fund and approximates the loss (or profit) in a certain probability (percentile). According to the PRIIPs RTS, the percentile for the MRM calculation is 2.5%, i.e. the probability for this loss is 2.5%, a rather low figure representing a worst case scenario.

    Based on the result of this calculation, a volatility that can lead to this loss (or profit) at a probability of 2.5% is calculated. This is called VEV, which stands for VaR Equivalent Volatility. The VEV is then mapped to a 1 to 7 scale MRM based on the buckets shown in the PRIIPs RTS, ANNEX II, PART 1, point 2:

    Regulatory Change

    Upon the expiry of the UCITS exemption from PRIIPs, UCITS funds will stop producing UCITS KIIDs and will begin generating PRIIPs KIDs. The timeline for the expiry should be published soon by the European Commission and is expected to be during 2022.  

    Our Evaluation

    To get ready for the upcoming change, we decided to perform a set of SRRI and SRI calculations. We started with equity funds. We took two large cap funds and two small cap funds and calculated their risk classifications. In all cases the PRIIPs SRI was lower than the UCITS SRRI:

    We also repeated the test for fixed income funds of two types: high yield funds and sovereign debt. The table below shows that the high yield fixed income funds also have a lower risk classification under PRIIPs. The sovereign debt moved in one case (which can be a function of long or short term). 

    Conclusions

    Fund managers should be prepared to lower risk classes for their funds. It is not advisable to voluntarily increase the SRI without a proper industry alignment. Instead, fund managers should communicate to distributors and investors that the reason for the lower risk is the change in methodology and not a real decline in their funds’ risk.

    Fund distributors should receive the new risk classes from fund managers in advance of the go live date. The Product Governance committees of the fund distributors should rethink the mapping of MiFID Target Market to their clients, assuming the new risk classes.