The FCA is proposing that performance scenarios are to be removed from KIDs and replaced with a narrative description of performance. In addition, VCTs are to be required to include a summary risk indicator score of no less than 6.
Not quite time to let your KIDs fly the nest, but hopefully some of the most fundamental issues will now be addressed as part of an FCA consultation announced on Tuesday.
Since their introduction on 1 January 2018 the Key Information Document ("KID") has been heavily criticised by stakeholders within the investment company industry, most recently at the beginning of this month by the AIC (The AIC - Beyond Frustrated). The key criticisms of the KID have been:
- the description of risk;
- confusion around how the risk indicator is calculated; and
- the potentially misleading use of future performance scenarios based on historic performance.
Following the UK's exit from the EU, the Financial Services Act 2021 granted the FCA powers to amend the information required to be included in the KID. On Tuesday, the FCA published a consultation paper (FCA Consultation Paper - CP21/23: PRIIPs - Proposed scope rules and amendments to Regulatory Technical Standards) setting out proposals to change the rules applicable in the UK that govern the information required to be included in the KID.
The PRIIPs Regulations were developed to increase the confidence of retail investors in financial markets and improve their protection. Advisers who produce, advise on or sell PRIIPs, such as shares in investment companies, are required to provide retail investors with a KID prior to the investor acquiring the product, for example shares in an investment company. The KID is intended to provide retail investors with a uniformed document to allow them to compare a wide range of products quickly and easily. As such the PRIIPs Regulations lay down uniform rules on the format and content of the KID and the provision of the KID to retail investors.
Included within the KID under the heading "What are the risks and what could I get in return?" is a brief description of the risk-reward profile of the product which includes, amongst other things, a summary risk indicator and appropriate performance scenarios, including the assumptions made to produce them. It is this section of the KID that the FCA has now accepted has the potential to contain misleading information due to the methodologies used in producing the performance scenarios and summary risk indicator. Alterative investment funds and investment trust companies are specifically identified in the FCA's consultation paper as examples of products where performance scenarios calculated in accordance with the current PRIIPs Regulations could be extremely misleading.
The Financial Services Act 2021 amended the requirement for the KID to have performance scenarios, replacing it instead with a broader and more flexible requirement for information on performance to be provided. This provides the FCA with the opportunity to explore different options for the presentation of performance information.
The changes proposed to the KID in the PRIIPs consultation paper are linked to the FCA's recent consultation on the new consumer duty. The FCA's new consumer duty is focused on ensuring that firms provide information which is understandable and helps consumers to make properly informed investment decisions. It is hoped that the proposed rule changes in relation to the PRIIPs Regulations will give firms greater flexibility to ensure that the information in the KID meets these requirements.
What the FCA is consulting on
The areas of the FCA consultation that are most likely to interest members of the investment company sector are the proposals to:
- replace the requirement and methodologies for presentation of performance scenarios in the KID with a requirement for narrative information on performance and factors that may impact performance;
- address concerns that there is potential for some investment companies to be assigned inappropriately low summary risk indicators; and
- address concerns around certain applications of the slippage methodology when calculating transaction costs.
The following are the key takeaways from the FCA consultation paper:
- Requirement to produce KIDs for products not intended for retail investors
Paragraphs 2.19 to 2.24 – The FCA is to provide clarification on whether KIDs are required to be produced for products where they are not intended for retail clients, but could be bought by retail investors, for example through a secondary market.
- Proposals to remove performance scenarios from KIDs
Paragraphs 3.10 to 3.14 – The FCA accept that the performance scenarios as they are currently prescribed pose a risk to consumers. The FCA is at the current stage proposing that the requirement to provide prescriptive performance scenarios is replaced with a narrative on expected performance and the factors that could impact this.
Paragraphs 3.16 and 3.17 – The FCA is proposing that KIDs include information on the main factors upon which returns depend, the underlying or reference values and how the return is determined. The narrative would also have to include a favourable, negative and worst case scenario in relation to how the investment could perform.
- Proposals to require VCTs to be assigned a summary risk indicator score of no less than 6 in KIDs
Paragraphs 3.30 to 3.33 – VCTs are identified by the FCA as a particular area of concern due to the majority of VCTs being identified as medium to low risk products in KIDs. This differs from the generally held view that VCTs are high risk investments. The low summary risk indicator scores are due to the methodology used to calculate the score and the frequency at which VCTs generally value their assets.
The FCA view that under-estimates of the overall risk of a product undermine a key objective of the PRIIPs Regulation and are therefore proposing a requirement on manufacturers to upgrade their product's summary risk indicator if they are of the view that the score produced by the PRIIPs methodology is too low. In addition, the FCA is proposing a requirement that VCTs must be assigned a summary risk indicator score of no less than 6 regardless of what score is calculated under the PRIIPs methodology, the nature of investments made by the VCT and the past performance of the vehicle.
This will be a significant change for the VCT industry with only a handful of VCTs currently including a summary risk indicator score of 6 in their KIDs and the majority being assigned a score of 3.
The FCA consultation closes on 30 September 2021 and it is currently intended that the changes to the KID will come into effect from 1 January 2022.