Opportunity in adversity: how will the KID for UCITS impact the asset management industry?
By Laurent Denayer*, Ernst & Young, Luxembourg
Luxembourg Fund Review (LFR)
January/February 2010 (issue 9)
Introduction
UCITS IV foresees a new document, replacing the simplified prospectus, entitled Key Investor Information (KII) for every UCITS. The Key Investor Information (KII), or Key Information Document (KID), has been one of the most controversial issues of UCITS IV (UCITS IV (Directive 2009/65/EC) recasts and replaces the old UCITS Directive (Directive 85/611/EC as amended)). In this article, I explore the impact of the KID on the asset management industry.
Regulatory background
“Key investor information shall include appropriate product information about the essential characteristics of the UCITS concerned, which is to be provided to investors so that they are reasonably able to understand the nature and the risks of the investment product that is being offered to them and, consequently, to take investment decisions on an informed basis (Article 78(2)of the recast UCITS Directive).”
The KID should provide investors with concise information about the UCITS written in plain language that is likely to be understood by the average retail investor. It is a pre-contractual document which must be provided to investors in good time before they subscribe to a UCITS. Where the UCITS is distributed cross-border, the KID must be translated into the official language, or one of the official languages, of the UCITS host Member State, or into a language approved by the authorities of the host Member State.
The investment company or management company, in the case of common funds, is responsible for providing a timely, consistent and accurate KID.
The form and content of the KID will be laid down in implementing measures to be adopted by the European Commission by July 2010. CESR issued its Technical advice to the European Commission on the level 2 measures related to the format and content of the Key Information Document disclosures for UCITS in October 2009.
It is proposed that each KID will consist of several sections that must be set out in a predefined order and with consistent headings to permit comparability between UCITS:
- Title
- Explanatory statement
- Name and identification of the UCITS by code number
- Name of the management company and group, if relevant
- A description of investment objectives and policy: the description given does not need to use the same wording as the investment objective and policy provided that this description is not inaccurate, not misleading and not materially inconsistent with the prospectus.
- Risk and reward profile, including guidance on the associated risks; this will take the form of:
- A synthetic risk and reward indicator (SRRI). The methodology for the synthetic risk and reward indicator is based on historical volatility and, for structured UCITS, on volatility as computed through reverse engineering from a Value-at-Risk (VaR) measure. CESR published the methodology for calculation of the synthetic risk and reward indicator in December 2009
- A narrative explanation of the main limitations of the indicator
- A narrative presentation or the material risks which are not fully captured by the methodology for the synthetic risk and reward indicator
- Charges. CESR published the methodology for calculation of the ongoing charges figure, in December 2009
- Past performance. In the case of structured funds, CESR has indicated that in place of past performance, an explanation of how the formula works or how the pay-off is calculated, accompanied by three scenarios, should be included in the investment objectives and policy section
- Practical information that should include details where to find unit prices, how to obtain copies of UCITS documents and accounts, and the name of the depositary. A statement regarding civil liability is also required.
- Authorization details
- Date of publication
The KID must be consistent with the relevant parts of the full prospectus. It should be provided to investors free of charge in a durable medium or by means of a website. A paper copy shall be delivered to investors on request. An up-to-date version should be made available on the website of the investment company or management company.
CESR has clarified that, in the case of umbrella UCITS, a separate KID must be produced for each sub-fund. In the case of multiple share classes, a separate KID must be produced for each share class, except where a share class can be selected to represent other share classes and certain conditions are met. In the case of master-feeder structures, a separate KID must be produced for each feeder UCITS.
While the deadline for implementing UCITS IV is 1 July 2011 simplified prospectuses must be replaced by KIDs as soon as possible and at the latest by 1 July 2012; it is generally assumed that KIDs should be produced for new UCITS created on or after 1 July 2011 while for existing UCITS simplified prospectuses must be replaced by KID by 1 July 2011.
The KID must be updated annually by the 25th business day in January and promptly following any material changes.
Perspectives on the KII
The controversial nature of the KII/KID can be seen from different perspectives.
- Will the KID mean lower costs for the asset management industry?
The KID will take the form of a 2 page document (3 pages for structured UCITS). It replaces the simplified prospectus which has proven to be an additional source of unnecessary costs for the industry and an instrument of a very limited use to investors.
Comparing the length of the KID with the simplified prospectus, one might conclude that the KID will be cheaper.
However, producing the KID for each sub-fund (compartment) and each share class could be costly. The KID must also be updated to reflect, for example, changes in the UCITS risk and reward profile, changes in charges, changes to the practical information and in the light of an additional year’s data on past performance. In volatile markets, changes in the UCITS risk and reward profile can mean that the KID must be updated. Further, validating the KID, as well as ensuring that it is kept up to date means increased compliance costs.
Although the Directive does not explicitly require it, it seems reasonable to assume that the KID must be translated (where relevant) and communicated to distributors without delay. It must also be communicated to the competent authorities, and an up-to-date version of the KII must also be made available on the website of the investment company or management company.
- Will the KID bring added value?
Retail investors show a strong interest in the KID and specifically the synthetic risk and reward indicator (SRRI). The SRRI is an indicator that is based on a numerical scale that would enable investors to compare UCITS risk and reward profiles. It is complemented by a short narrative description of the limitations of the indicator as well as on the risks not fully captured by the indicator. The SRRI is based on the volatility of the returns (past performance) and offers the benefits of uniformity and brevity. CESR provides a methodology to compute the SRRI which includes volatility intervals, rules on moves between risk categories as well as specific methodology for absolute return funds, total return funds, life cycle funds and structured funds.
For feeders UCITS, there should be a close correlation between the SRRI of both the master and the feeders.
The KID will bring also an increased transparency in terms of fees. This may lead to downward fee pressure from investors.
The methodology for the calculation of the ongoing charges figure is fairly prescriptive, but could lead asset management groups to change their fee structure. For example, there could be renewed interest in performance fees.
Furthermore, the KID enables investors to compare past performance of UCITS.
Thus, overall, the KID allows investors to compare UCITS risk profiles, fees and performance.
- Will the KID create new revenue opportunities?
As discussed above, the production of KIDs is the responsibility of investment companies or management companies. However, it could be delegated to fund administrators, or even to specialized service providers. Such service providers could also provide other KID-related services, such as translation, periodic calculation of the SRRI and past performance. They could provide document production, management and communication services not just for the KID but also for other documentation produced for the fund, such as the prospectus, financial statements and marketing materials.
Furthermore, some service providers may go further and provide UCITS benchmarking services, for example to asset managers and investors, based on analysis and comparison of KIDs.
This could represent significant opportunities as well as new market positioning.
Conclusion
Although the added value of the KID has been a controversial issue, its impact on the asset management industry should not be underestimated.
The KID means implementing new ways of communicating the risk and reward profile of the fund, as well as the provisions on charges and past performance. Groups may decide to change their fee structures. New service providers may provide KID production, management and distribution services, and even help investors identify the best funds.
In the long run, the KID may be as strong a driver for fund rationalization as any of the other provisions of UCITS IV.
*Laurent Denayer, Financial Services Risk Management Leader and Strategy and Risk Management Leader for UCITS IV services Ernst & Young, Luxembourg
Posted on 23 March 2010
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