The German structured products industry is concerned about the viability of the requirements around performance scenarios introduced by the Joint Committee of the European Supervisory Authorities (ESAs) in its final proposal for regulatory technical standards (RTS) released in April this year.
"The main message here is that an EU-wide calculation guidelines makes uniform performance scenarios for structured products possible for the first time ever," says Andre Fischer (pictured), director at Smarttra.de. "In Germany issuers have been publishing performance scenarios for the past 5-6 years, but there was no standard procedure on a national let alone European level. [The novelty] is that these performance scenarios are mandatory."
In a recently issued research paper, Priips - New Performance Scenarios for Certificates, by Smartrra.de, the FinTech firm and software as a service (SaaS) provider, offers some conclusions on the viability of this requirement. "The disadvantage for issuers is that the IT systems have to be adjusted [and this] involves cost and time, without being certain about the added value for investors," says Fischer. "There is a discussion about this issue in Germany where banks have got a diverse view on this matter."
According to Fischer, the positive consequence of the new rules is the standardisation of the calculation that makes certificates performances comparable across Europe, and also across other asset classes such as mutual funds and exchange-traded funds (ETF's). "However, the main question remains whether this Priips (packaged retail and insurance-based investment products) regulation justifies the means and offers more support for investors to make better investment decisions," says Fischer.
The requirement to provide three performance scenarios not only for product performances on the day of maturity, but also for intermediate terms, poses a challenge from a calculation stand point, according to Fischer. "The intermediate performance scenario calculation has to be performed for several time periods, and the scenarios have to be transformed into the value of the certificate," says Fischer. "In addition the calculation for each key information document (Kid) needs to be updated overnight, daily. For real time issuance the scenarios need to be calculated at the moment of issuance. That implies a sophisticated technology as results are to be shown within seconds. This is partly unknown territory which is a challenging project to many banks and that makes outsourcing of these processes attractive."
The German association (Deutscher Derivate Verband - DDV) has also published an assessment on the proposed methodology with an analysis of the impact of the provisions of performance scenarios on leverage certificates. According to Christian Vollmuth, managing director at the DDV the results of this report highlight the fact that these requirements are not adding value to investor protection by displaying the performance scenarios for leverage products and therefore the DDV is proposing a different approach in its latest DDV Priips-Report 5.
"The results for the performance scenarios for these products are (by large) questionable due to the speculative nature of the products (with high leverage) and the proposed calculation approach (e.g. showing per annum figures for products with short maturities / holding periods)," says Vollmuth. "The main factors driving the unrealistic results are, in addition to the leverage character of the products, the annualisation of the returns and the maturities. Presenting such dubious figures for leverage products in the Kid is of no added value for Priips investors and will result in a high update frequency for the Kid of these products."
In order to address the nature of leverage products as speculative investments that are heavily influenced by even low market movements, the DDV proposal consists in providing a more generic Kid with generic payoff charts instead of performance scenarios, according to Vollmuth.
"The issues around performance scenarios are an example of the unrealistic timeline for the implementation of the new rules," says Thomas Wulf, secretary general at the European trade body (Eusipa). "The industry tries to advance with this process as fast as we can," says Wulf. "However there are simply too many known unknowns that prevent us from finding a final fix for all open technical questions. Uncertainties with regard to grandfathering and update requirements are but two albeit very relevant examples that impact performance scenarios though extend also beyond them. Whilst the EU institutions promised to deliver clear guidance within an acceptable timeframe we still lack information on fundamentals on what is called "level 1". Hence the implementation process will very likely be delayed."
Practice will "ultimately show how these scenarios are being perceived by investors", according to Wulf. "Enough has been written on behavioural finance that made us initially hope that anything the industry would be asked to disclose was tested extensively before on consumers," says Wulf, adding that such impact assessments "have been done here and there as we know but there was never a fact-based reasoning if you want to call it that way, on why the solutions finally proposed in the RTS has been preferred over others".
"It is interesting to hear that currently the asset management industry heavily lobbies for changing the performance scenarios in a way that they include past performance data as they do in the Ucits Kid," says Wulf. "I wonder how the European institutions will react to this."
According to Wulf, this is only one of the areas where the industry has no legal certainty. "Such areas of uncertainty relate to inconsistencies between level 1 and level 2, issues raised by the interpretation of the draft RTS, issues coming from Priips areas not addressed in the draft RTS and finally, coherence problems between Priips regulation and other EU law, most notably the Mifid 2 directive," says Wulf. "One major problem for us as an industry in general is whether, and if so to what extent, the Priips regulation allows for national gold-plating."
In the eyes of Eusipa any such effort by national regulators to change the fundamentals of the Kid claiming that is a "necessary adaption to the national market", would contradict the very underlying idea of the Priips regulation, namely to create a level playing field for retail financial products in Europe, according to Wulf.
"However I am not sure that everyone shares this view given that consumer protection of which the Kid delivery forms an integral part, always is a key item in national politics," says Wulf.
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