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Important note: In this paper, we discuss our views on EU regulatory requirements for PRIIPs KID calculations common to various types of PRIIPs. PRIIPs come in various shapes and flavors. This paper covers many, but not all, elements of EU PRIIP regulations relevant to KID calculations. Each PRIIP is unique and some aspects of EU regulations that are relevant for a specific PRIIP might not be covered in this paper.
This paper should not be taken as legal advice or as an opinion specific to a given PRIIP. This paper presents our own general interpretation of PRIIPs KID regulations based on our professional experience applicable to certain cases and based on certain laws and regulations in force as of the date of this paper. Laws and regulations can change, which could affect the relevance of certain statements in this paper. Readers should exercise their own professional judgement and are encouraged to seek external professional advice from AN Valuations B.V. and our network of legal partners.
Packaged retail investment and insurance products (PRIIPs) are investment products typically offered to consumers. Taken together, PRIIPs make up a market in Europe worth up to €10 trillion.
Despite their potential benefits, PRIIPs can be complicated and lack transparency. To tackle this, the EU adopted regulations (EU 1286/2014, EU 2017/653, and EU 2021/2268, amongst others) that oblige PRIIPs producers and sellers to provide retail investors with key information documents (KIDs). KIDs should be a maximum of 3 pages and provide clear information on investment products including prescribed risk, return and cost calculations.
Producing an effective KID comes with challenges:
The above-mentioned EU regulations provide 4 categories of PRIIPs, each with its own approach to certain KID calculations.
Category 1 refers to PRIIPs where investors could lose more than they invested; derivatives and similar contracts; and PRIIPs (or its underlying investments) that are priced less than monthly, do not have an appropriate benchmark or proxy, or have a benchmark or proxy that is priced less than monthly.
Category 2 PRIIPs offer non-leveraged exposure to the prices of underlying investments or a leveraged exposure on underlying investments that pays a constant multiple of the prices of those underlying investments. At least 2 years of historical daily, 4 years of historical weekly, or 5 years of historical monthly PRIIP (or benchmark) prices should be available.
Category 3 refers to PRIIPs whose values reflect the prices of underlying investments, but not as a constant multiple. At least 2 years of historical daily, 4 years of historical weekly, or 5 years of historical monthly PRIIP (or benchmark) prices should be available.
Category 4 refers to PRIIPs whose have values depend in part on factors not observable in the market, including insurance- based PRIIPs that distribute a portion of the PRIIP manufacturer’s profits to retail investors.
A KID contains a risk measure (also known as ‘summary risk indicator’ or SRI), performance scenarios, composition of costs, and the impact of fund costs on the investment return. SRI is a rating from 1 (least risk) to 7 (highest risk). The performance scenarios and impact of costs on the investment return are calculated for multiple holding periods and expressed in both percentage and monetary terms.
The composition of costs is divided into 3 main buckets – one off, ongoing, and incidental. One off costs are divided into entry and exit costs. Ongoing costs are divided into transaction and other costs. Incidental costs refer mainly to performance fees.
We discuss each of these concepts in more detail in his paper.
The information contained in a KID should enable investors to understand and compare the investment risks of a given PRIIP so that they can make informed investment decisions. The risks pertaining to a PRIIP can vary. EU regulations address market risk (volatility of returns), credit risk (ability to pay investors) and liquidity risk (ability to buy or sell units in the PRIIP).
The summary risk indicator (SRI) aggregates market risk and credit risk into a single numeric indicator, complimented by sufficient narrative explanations. Liquidity risk is handled separately from SRI.
Market risk measure (MRM) is a measure of the volatility of a PRIIP and is expressed as a rating from 1 (lowest risk) to 7 (highest risk). MRM is based on the annualized volatility corresponding to the value-at-risk (VaR) at a confidence level of 97.5% over the recommended holding period. An MRM score (MRM class) is based on the VaR-equivalent volatility (VEV) in accordance with the table below:
| MRM class | VaR-equivalent volatility (VEV) |
| 1 | < 0,5 % |
| 2 | 0,5 % – 5,0 % |
| 3 | 5,0 % – 12 % |
| 4 | 12 % – 20 % |
| 5 | 20 % – 30 % |
| 6 | 30 % – 80 % |
| 7 | > 80 % |
Category 1 MRM is fairly straightforward. MRM is 6 for category 1 PRIIPs (or their underlying investments) that are priced less than monthly, do not have an appropriate benchmark or proxy, or have a benchmark or proxy that is priced less than monthly. MRM is 7 for all other types of category 1 PRIIPs.
Category 2 MRM is more complicated. VEV is calculated from the moments of the observed distribution of returns of the PRIIP, or its benchmark or proxy’s price, during the past 5 years. VaR and VEV formulas and the required data frequency are prescribed in EU regulations. The specific formulas and their explanations are beyond the scope of this paper.
Category 3 MRM relies on simulated PRIIP values. VaR in price space is calculated from a distribution of PRIIP values at the end of the recommended holding period. The distribution is obtained by simulating the price or prices, which determine the value of the PRIIP, at the end of the recommended holding period. The minimum number of simulations is 10,000. The VaR is the value of the PRIIP at a confidence level of 97,5 % at the end of the recommended holding period discounted to the present date using the expected risk-free discount factor.
Category 4 MRM begins with dividing the PRIIP into components that are (partly) observed in the market and those that are not. Components that are (partly) dependent on factors observable in the market are treated as category 1, 2, or 3, as appropriate. Components that are (partly) dependent on factors that are not observable in the market should follow robust and well recognized industry and regulatory standards for determining expectations as to the future contribution of these factors and the uncertainty in respect of that contribution. Where a component is not wholly dependent on factors that are unobserved in the market, a bootstrap methodology is used to account for the market factors, as set out for Category 3 PRIIPs. The resulting VEV results from the combination of the bootstrap methodology and robust and well recognized industry and regulatory standards.
CRM is a rating from 1 (least risky) to 6 (most risky) that expresses the creditworthiness of a PRIIP. It reflects the ability of a PRIIP to pay its investors. Credit risk is measured for the PRIIP, entities that pay investors on behalf of the PRIIP, and the PRIIP’s guarantors.
Where available, a PRIIP manufacturer should define (ex-ante) one or more external credit assessment institutions (ECAI) that are certified or registered with the European Securities and Markets Authority (ESMA) in accordance with EU Regulation (EC) No 1060/2009 of the European Parliament and the Council whose credit assessments would consistently be referred to for the purpose of the credit risk assessment. Where multiple credit assessments are available, the median rating is used. In case of an even number of assessments, the lower of the two middle values is used.
The level of credit risk of the PRIIP and each relevant obligor should be assessed on the basis of, as applicable:
The allocation of credit assessments of ECAIs to CRM should be based on Commission Implementing Regulation (EU) 2016/1800, which provides tables that express credit ratings as “credit quality steps” from 0 (strongest) to 6 (weakest). Certain credit quality steps may then be adjusted based on PRIIP maturity or recommended holding period (RHP) in accordance with the table below.
| Credit quality step | Maturity or RHP up to 1 year | Maturity or RHP 1 to 12 years | Maturity or RHP more than 12 years |
| 0 | 0 | 0 | 0 |
| 1 | 1 | 1 | 1 |
| 2 | 1 | 2 | 2 |
| 3 | 2 | 3 | 3 |
| 4 | 3 | 4 | 5 |
| 5 | 4 | 5 | 6 |
| 6 | 6 | 6 | 6 |
If the obligor has no external credit assessments, the default credit assessment is:
The credit quality step can be adjusted by the following conditions:
The CRM may be assigned as 1 where the assets of a PRIIP or appropriate collateral, or assets backing the payment obligation of the PRIIP, are:
The CRM may be assigned as 2 where the assets of a PRIIP or appropriate collateral, or assets backing the payment obligation of the PRIIP, are:
Where credit risk is to be assessed on a look-through or cascade basis, the mitigation factors under the 2 paragraphs above may also be applied when assessing credit risk in relation to each underlying obligor.
Where a PRIIP is not able to satisfy the above criteria, CRM may be reduced by one class where the claims of retail investors have priority over the claims of ordinary creditors (see Article 108 of Directive 2014/59/EU) of the PRIIP manufacturer or of parties that make payments investors on behalf of the PRIIP (if that party is subject to relevant prudential asset and liability matching requirements).
The CRM is increased by two classes where claims of retail investor are subordinate to claims of senior creditors.
The overall summary risk indicator (SRI) is assigned according to the combination of the CRM and the MRM classes, in accordance with the following table:
| MR1 | MR2 | MR3 | MR4 | MR5 | MR6 | MR7 | |
| CR1 | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
| CR2 | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
| CR3 | 3 | 3 | 3 | 4 | 5 | 6 | 7 |
| CR4 | 5 | 5 | 5 | 5 | 5 | 6 | 7 |
| CR5 | 5 | 5 | 5 | 5 | 5 | 6 | 7 |
| CR6 | 6 | 6 | 6 | 6 | 6 | 6 | 7 |
Liquidity risk basically reflects the ability of investors to buy or sell units in a PRIIP. While there generally may not be calculations for determining liquidity risk, we include it in this paper as it is meant to augment the KID with additional information relevant to the PRIIP and SRI in particular.
A PRIIP has materially relevant liquidity risk under either of the following conditions:
A PRIIP is considered illiquid under either of the following conditions:
A PRIIP shall be considered liquid in all other cases.
A warning must be included directly below the SRI if a PRIIP is considered to have a materially relevant liquidity risk or to be illiquid, whether this is contractual in nature or not.
The KID should show four performance scenarios showing a range of possible outcomes: a) favorable, b) moderate, c) unfavorable, and d) stress. The minimum investment return should also be shown (not taking into account the situation where the PRIIP manufacturer or party bound to make payments to the investor, is not able to pay). Specific calculation methodologies differ quite a bit between PRIIP categories and are out of the scope of this paper.
Performance scenarios should be shown for one or more holding periods, depending on the recommended holding period (RHP) of the PRIIP.
For PRIIPs with a recommended holding period (RHP) of 10 or more years, performance should be shown at 3 holding periods: end of first year, half of the RHP, and at the end of the RHP.
For PRIIPs with an RHP between 1 and 10 years, performance should be shown at two different holding periods: at the end of the first year and at the end of the RHP.
For PRIIPs with an RHP up to 1 year, performance scenarios for intermediate holding periods should not be calculated.
Performance scenarios should be calculated net of costs and presented in both monetary units and in percentage terms.
Performance expressed in monetary units should generally be rounded to the nearest EUR 10, unless that could be misleading. Performance should be based on amounts received by the investor during the holding period (such as coupon and other distributions) and amounts due at the end of the investment period. Performance must exclude income reinvestment.
For RHPs less than 1 year, performance should not be annualized. For RHPs more than 1 year, performance should represent average annual return.
There are 3 main categories of fund costs: one-off, recurring, and incidental. One-off costs are entry or exit costs that are not deducted from assets under management (AUM). Recurring costs are deducted from AUM and include fund operating expenses, payments to fund service providers, and transaction costs. Incidental costs include performance fees and carried interest.
Fund costs should be expressed in both EUR and percentage terms. One-off costs should be broken down into entry and exit costs. Ongoing costs should be divided into transaction costs and other. Incidental costs should be shown together as one group.
Transaction costs should be shown separately from other ongoing costs, both in monetary and percentage terms. Transaction costs should be calculated on an annualized basis over the previous 3 years based on the average of transaction costs over that period.
The KID for most PRIIPs should include a table showing total costs based on an investment of EUR 10,000 and the annual cost impact for each measurement period described above in the Performance Scenarios section. The annual cost impact shows the difference between the investment return before costs and the investment return after costs.
According to EU regulations, PRIIP manufacturers are required to review the KID whenever there is a change that significantly affects (or is likely to significantly affect) the KID and at least every 12 months following the date of initial publication.
The KID must remain accurate, fair, clear, and not misleading. In particular, a review must verify the following:
PRIIP manufacturers must establish and maintain adequate processes throughout the life of the PRIIP that remain available to retail investors to identify (without undue delay) any circumstances that might result in a change that affects, or is likely to affect, the accuracy, fairness or clarity of the KID.
PRIIP manufacturers must, without undue delay, revise the KID when a review (as described above) concludes that changes to the KID need to be made. The PRIIP manufacturer must publish the revised KID on its website.
EU regulations prescribe risk, return and cost measures for investment products sold to retail investors. These can differ depending on the type of investment. The rules are extensive and the calculations can be complex. Contact Andrew Pike, managing director of AN Valuations at +31 70 221 0058 or via email at info@anvaluations.com to learn more.