By George McCutcheon, Research Director at FRS
On 8 March 2017, the European Commission published revised RTSs. As firms need to refer to the RTS in order to compile the key information document (KID), firms need access to the finalised RTS in order to comply with the PRIIPs Regulation.
PRIIPs Implementation Challenges:
In answer to a poll question at a recent PRIIPs-focused webinar, 55% of respondents said that their organisation’s main PRIIPs implementation challenge was the calculations. Unfortunately, the calculation challenge is further exacerbated because there are mistakes in the RTS formulae which don’t appear to have been noticed or corrected in subsequent regulatory material, even as recently as the August 2017 PRIIPs flow-diagrams!
It remains to be seen when appropriate errata will be published, but in the interim, firms need to be;
- able to apply common sense checks to their PRIIPs calculation results
- ready to quickly amend their calculation formulae as and when a revised RTS corrigendum is published
Companies might well ask “What are the potential consequences of mistakes in the PRIIPs calculations?”. There is the customer civil liability risk arising from inaccurate KIDs, the reputational risk to the company and the risk of regulatory sanctions. Companies will be aware that the FCA is proposing to amend its Enforcement Guide setting out its approach to investigations under the PRIIPs Regulation and to change the Decision Procedure and Penalties manual for the PRIIPs Regulation.
The RTS Formulae Mistakes:
The RTS formulae mistakes are in respect of the stressed performance figures – e.g. the formula in paragraph 11 of Annex IV is clearly wrong on two different sets of common sense checks;
- firstly, the formula gives a 0% return for a scenario where the unit prices increase by a constant percentage uniformly over the five-year historic period
- secondly the structure of the formula is incorrect – it should have a structure consistent with the formulae for the unfavourable, moderate and favourable scenarios incorporating terms based on the mean and the volatility. There is clearly a missing term which has been suggested by Insurance Europe to be M1*N.
Suggested Testing Methodology:
A good test currently is to apply the Category 3 bootstrapping approach of 10,000 simulations to a Category 2 fund and to compare the ratios of the Category 3 accumulation factors to their Category 2 equivalents. This would serve as a good cross-check test on both Category 2 and Category 3 results.
At software firm Financial Risk Solutions, we have completed this exercise and found that the ratios were within 1% (and indeed 0.1% for some scenarios and durations) – a very good check that the formulae errors in both Category 2 and Category 3 have been identified.
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