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Mario Mantrisi: Prips complexity risk confusing investors

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Last October, the European Parliament’s Committee on Economic and Monetary Affairs voted in favour of the Prips proposal. A new part of the proposal was the requirement for investment products to introduce a label to their Key Information Document that lets investors know whether a fund is ‘complex’ or ‘non-complex’.

But is this measure overcomplicating investors’ jobs by adding such labels to Prips? Some fund managers we have spoken to seem to think so. They have made it clear that they think the latest proposal contain ‘unnecessary’ additions that do not do justice to certain investment products and serve to further complicate disclosure rules.

Critics say introducing the ‘complexity label’ will only serve to confuse investors.

Fund managers point out that there are already risk indicators built into the Prips KID and that any new labels would merely add superfluous classifications of funds.

Under the new version of Prips, products that present their risk-reward profile or costs in an overly complicated manner, or those that invest in underlying assets not commonly invested in by non-professional investors, will be required to carry a complex label on their KID.

Those funds that use a number of different mechanisms to calculate the final return on the investment, or have a global exposure measured by value at risk of over 20 per cent, would also fall into the complex category. However, to define an investment as complex is ultimately a matter of subjectivity.

There is also the worry that some retail investors may associate complex with meaning risky, which is not necessarily true. Many financial products have complex structures, without necessarily being riskier, and this may lead to investors with low risk thresholds unwittingly missing out on the full range of products that are suitable for them.

The knock-on effect of this is that some fund managers looking to market a fund labelled as complex, or otherwise including complex elements as part of a fund strategy, may be disadvantaged.

This is a concern to many fund managers because the aim of most new disclosure rules has been to make it easier for investors to compare different investment products and understand the different strategies on offer.

Indeed, a large part of the success of the Ucits framework and its Key Investor Information Document has been the fact that it has focused on adding simplicity, consistency and standardization to the marketing of different funds.

It is for this reason that the latest Prips proposal has met with a mixed reaction from the Ucits community too. Ucits fund managers have been debating complexity labels for years and so many will be loath to see the argument raised yet again.

While Ucits funds will be exempt from the Prips regulation to begin with, they will be required to comply three years after the new rules come into force. It is therefore possible that in the future, certain Ucits funds could also be forced to carry a complexity label.

In addition, the EU Parliament text carries forward a provision on a product approval process. This measure is hard to understand for the fund industry, as their products usually undergo a severe approval process before marketing to retail investors.

The proposal also suggests including a separate annex that has to be issued by the distributor and needs to be remitted together with the KID to the final investor.

The text also suggests that regulators should develop an online fund analyser which would allow investors to calculate the end value of their investment after fees and costs have been taken into account. This sounds easy and logical in theory, however, in practice this could turn into a tricky situation to implement, with its inherent liability risks.

Finally, on the risk management side, the proposal includes a certain number of rules on payoff, such as where the investment product shall not be conditional upon the occurrence of events uncommon for retail investors, such as the level of regulatory capital of a financial institution.

The European Parliament’s job is therefore not an easy one. There are many different sets of interests to manage, while also ensuring that the final goal is met by changing markets for the better.

It is understandable that fund managers are voicing their concerns, as Prips has already been expanded to include a wide variety of elements that were not originally thought to fall under its scope. In addition to adding complexity labels, the European Parliament also wants to expand it even further to include shares, bonds and many other types of financial instruments.

Whether the complexity label ends up as part of Prips, the question that must be asked is whether regulation itself is becoming too complex and whether the latest changes are in fact in the interests of the end user – the investors.

Mario Mantrisi is chief strategy and research officer at KNEIP

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