Dear Clients and Friends,
It is a common assumption that the EU’s PRIIP Regulation “the PRIIP Regulation” has no relevance to the alternative investment management sector because it applies solely to retail investors. In fact, PRIIP takes a much broader view of who is a retail investor, and is likely to capture employees, as well as friends and family of the investment manager. In this alert, we take a look at the requirements of the PRIIP Regulation and the implications for all managers who take on this new category of investor.
What is the PRIIP Regulation?
“PRIIP” is an acronym for "Packaged Retail and Insurance-based Investment Product". It applies to a wide range of investment vehicles, irrespective of their legal form, where the amount ultimately payable to investors relates to underlying assets that may fluctuate in value. It therefore includes all types of fund, irrespective of where they are domiciled.
The PRIIP Regulation introduces a harmonised regime across the entire EU aimed at improving the transparency of such vehicles to retail investors, to ensure that they understand the associated risks and costs and are able to make choices across different funds using comparable information. The required disclosures include a Key Information Document “KID” which must be provided to investors at the point of sale.
The PRIIP Regulation comes into force on 1 January 2018
When is the PRIIP Regulation Relevant to Investment Managers?
The PRIIP Regulation applies to the manufacturer of the product, typically the investment manager, plus any person selling or advising on the PRIIP such as a distribution agent.
The PRIIP Regulation comes into focus whenever the investment manager or its distributors "make available” their funds to retail investors, as defined below. This makes the PRIIP Regulation potentially relevant to unregulated funds as well as more traditional retail funds such as UCITS.
"Make available" is widely defined and does not distinguish on the basis of how the investor was approached or whether advice was provided. Consequently, unlike AIFMD, there is no concept of reverse solicitation under the PRIIP Regulation.
How Does the PRIIP Regulation Define Retail Investors?
Again, more broadly than the current MiFID definition.
Under next year’s MiFID II, as is the case currently, retail investor means anyone who is not a professional client, or an eligible counterparty. Anyone who is not a per se professional client must be assessed on the basis of both qualitative and quantitative tests before they may be opted up to elective professional status.
Currently, managers have been able to opt-up employees, friends and family on the basis of the qualitative test alone: being sufficient knowledge and experience with regard to the relevant financial instruments and, therefore, being capable of understanding the impact of their decisions and of the inherent risks involved.
Going forward however, opting up employees, friends and family to professional client status will also require these investors to meet two out of the following three quantitative tests:
- That the investor has carried out an average of ten transactions per quarter over the previous four quarters in the relevant instrument. i.e. the fund;
- That the investor’s, relevant, financial instrument portfolio exceeds €500,000; and
- That the investor works or has worked in the financial sector in a professional position which requires knowledge of the transactions envisaged.
Although most staff, friends or family will often fulfil at least one of the above criteria, it is relatively unusual for such individuals to meet a second; especially noting the soon to be ‘chicken and egg’ quandary of the first criteria. Therefore, most individuals will have to be treated as retail investors for the purposes of the required KID disclosures.
Note also that, under MiFID II, local authority clients will be subject to their own opt-up criteria, and if these are not satisfied they must be treated as retail clients and receive the KID disclosure. In practice, however, the opt-up criteria for local authority clients, which we can provide on request, are somewhat more straightforward.
What about Investors outside the EU?
They are not caught by the PRIIP Regulation which applies only to investors located inside the EU.
What has to be provided in the KID?
Not to be confused with the UCITS, Key Investor Information Document “KIID”, there is a very prescriptive format for the KID – this is set out in a separate Delegated Regulation (2017/653):
- A maximum of three pages of A4;
- In a standardised format and content prescribed in the PRIIP Regulation, see below;
- Provided in clearly expressed, easy to understand language;
- No colours or corporate branding that may distract the reader; and
- If distributed in another EU state, translated into the official language of that state.
Here is a summary of the content that must be provided in the KID, as set out in the template provided in the Delegated Regulation:
- The title “Key Information Document” displayed prominently at the top of the page;
- The purpose of the document – key information about this investment product;
- The name of the product. i.e. the fund;
- A warning that the product may be difficult to understand;
- A description of the product – type, objectives, target investor;
- A description of the risks and potential rewards: risk indicator, on a scale of 1-7 and performance scenarios;
- What happens if the manufacturer is unable to pay-out;
- Details of all costs to be borne by the investor, including transaction costs and ongoing costs expressed in terms of impact on yield;
- Recommended minimum holding period;
- How to complain; and
- Other relevant information.
If I Already Provide a KIID, Do I still need to provide a PRIIP KID?
Yes, the format of the PRIIP Regulation KID is currently different to the KIID required under the UCITS Directive. However, there is provision within the PRIIP Regulation for a review which may harmonise the two regimes. Nonetheless, in the short term, it is possible that affected managers will have to prepare both forms of disclosure.
Does this Affect Existing Investors?
As mentioned before, the KID must be provided at the point at which the product is made available to the prospective investor. Therefore, on our reading, this will exclude current individual investors in the fund – there is no need to provide the KID in retrospect. However, if any such investors are considering increasing their investments, then the KID must be provided before they do so.
What are the Penalties for Non-Compliance?
The PRIIP Regulation lays down potentially heavy sanctions for non-compliance. These can include fines up to €5 million, or twice the amount of profits gained by avoidance - as well as public censure or prohibition orders banning further marketing of the product.
As with most regulations around the marketing of financial products, managers also expose themselves to the risk of damage claims from aggrieved investors individually or possibly by class action.