UK Regulator Consults on Scope of PRIIPs

The U.K. Financial Conduct Authority has published proposals to amend the scope of the rules governing packaged retail and insurance-based investment products (or PRIIPs). The FCA's proposals are designed to bring legal certainty to the scope of the PRIIPs regime, as it applies to corporate bonds. The consultation also addresses issues of misleading performance scenarios and summary risk indicators and concerns about the transaction costs calculation methodology. It is hoped that the amendments will promote liquidity and improve choice in the retail corporate bond market and also reduce the complexity of key information documents (or KIDs), the key information disclosure documents that must accompany PRIIPs when they are made available to retail investors.

Responses to the FCA's PRIIPs consultation should be submitted by September 30, 2021. The FCA is aiming to finalize the amendments by the end of this year and for the changes to take effect on January 1, 2022.

The U.K. PRIIPs regime is based on the EU PRIIPs Regulation and Regulatory Technical Standards, which the U.K. onshored with minor amendments following its exit from the European Union. The main U.K. legislation is the onshored U.K. PRIIPs Regulation and the Technical Standards. The U.K. Financial Services Act 2021 made some amendments to the U.K. PRIIPs Regulation, the combination of which has led or will lead to differences between the EU and the U.K. PRIIP regimes. The FCA has been granted new power to make rules specifying whether a product or product category falls within the definition of a PRIIP. In addition, performance scenario requirements have been replaced with a more flexible requirement for "information on performance" to address industry concerns that in certain circumstances performance scenarios could be misleading.

Proposed Scope Rules

The FCA's proposed new scope rules, which will have legal effect, aim to clarify whether certain features of corporate bonds make a product a PRIIP. The FCA's proposed rules set out:

1. Debt securities that are PRIIPs

These are financial instruments where the level of interest payable, any conditionality of principal repayment or the issuer's default risk is linked to:

• fluctuations in reference indices or benchmarks relating to investment assets, excluding the Bank of England official Bank Rate and benchmarks or indices that relate to the performance of the general economy (e.g., those tracking the rate of inflation or money market interest rates); or
• the value or performance of reference assets, including a basket of shares; or
• the value or performance of investments held by the issuer (or an entity connected to the issuer, including members of the same group), such as derivatives, real estate, a pool of receivables, or a portfolio of securities.

2. Debt securities that are not PRIIPs

A debt security would not be a PRIIP where the:

• return on the security is determined by the economic performance of the issuer's (or, where a bond is guaranteed by a group entity, that entity's) commercial or industrial activities. The FCA adds that lending, investment, and any other financial sector activities would not be considered commercial or industrial activities of an issuer; and
• terms of the debt security do not impose any modification, structuring, or conditionality on the issuer's obligation to pay interest or repay the principal, except for the effect of certain neutral features.

3. Features of debt securities that are neutral

The following "neutral" features would not cause a debt security to be considered a PRIIP:

• Fixed rate bonds, even if the coupons are subject to pre-defined changes (because the returns to investors for these investments are not subject to fluctuations).
• Floating rate bonds, provided the interest payable is: (i) determined by the Bank of England official Bank Rate or indices that relate to the performance of the general economy, with or without a spread indicating the issuer's credit risk and (ii) not subject to any modification or structuring, for example, a cap or a floor other than zero.
• Subordinated bonds and bonds with perpetual or indefinite terms.
• A put option where the investor has a discretion to demand early repayment of the debt security on pre-agreed terms, or to convert or exchange into one or more shares of the same issuer at a pre-determined price.
• A call option that permits the issuer to redeem early at least at par, provided that exercise of the option is not linked to fluctuations in reference values or investment asset performance and the mechanism to calculate the net present value of the future coupon payments is made clear to the investor.

The FCA also intends to introduce a rule to clarify that a financial instrument issued or sold before January 1, 2018, is not a PRIIP, even if it remains available for trading on a secondary market to retail investors.

Proposed Guidance on "Made Available"

Under the PRIIPs Regulation, issuers must produce a KID whenever PRIIPs that they are issuing are "made available" to U.K. retail investors. There is some ambiguity in terms of the meaning of "made available," which has led some firms to produce a KID even where they do not intend to sell the product to retail investors, to avoid inadvertently falling foul of the rules. To combat this, the FCA proposes new guidance setting out the conditions in which a PRIIP will not be "made available" to retail investors, namely:

• it is clear from the marketing materials, including the prospectus if there is one, that the financial instrument is only being offered to "investors eligible for categorization as professional clients or eligible counterparties under the FCA's rules" and is not intended for retail investors;
• the issuer and, for the secondary markets, the distributor take reasonable steps to ensure that the financial instrument is targeted at only investors eligible for categorization as professional clients and eligible counterparties; and
• the financial instrument has a denomination or minimum investment of £100,000.

Notably, according to the text of the proposed guidance, a financial instrument would not be considered as being 'made available' to a retail investor where it is made available to a retail investor that has opted to be a professional client (i.e. an elective professional client).

Proposed Changes to the PRIIPs TS

The U.K. PRIIPs Regulation requires certain information, including in relation to aggregate costs and charges, investment risk and information on performance, to be disclosed in the KID. The PRIIPs TS set out the detailed information that must be included and the methodologies for calculating and presenting the information. The FCA is proposing to make numerous changes and improvements to the existing PRIIPs TS, ranging from information on performance and risk to transaction cost disclosure requirements. The proposals are discussed in the consultation paper and a mark-up of the PRIIPs TS text is in an annex.

View the FCA's consultation paper.

You may like to view our client note, UK PRIIPs Review, which provides further details on this consultation.

You may like to view our client note "UK Conduct Regulator Proposes Consumer Duty for Retail Activities."

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