The introduction of major new rules and regulations moves rapidly closer. As we find ourselves already well into 2011, many a sales director would be glad of a pipeline of new business as full as the UK & EU regulators’ pipeline of new policies.
The new regulation with potentially the most immediate and visible effect to investors will derive from the UCITS IV Directive that will take effect on July 1. Luxembourg is once again the European pacesetter, being the first country to write the requirements of the Directive into national law. In the UK, the FSA’s proposals are circulating in a consultation paper open until the March 21.
Disclosures Essential to Investors' Decisions
Although there is half a dozen key aspects to the Directive, spanning intra country regulatory co-operation, simplifying management, marketing & mergers of funds’ cross borders, and the provision for master-feeder funds, it is the improved investor disclosure features that have been grabbing the early headlines.
Under these investor disclosure terms of the Directive, every UCITS must replace its Simplified Prospectus with a new two- or three-page pre-contractual Key Investor Information Document (KIID) designed to provide information that is essential to investors’ decisions. Format and content of the KIIDs are highly prescribed and must include, in order, identification of the fund, details of its investment objective and policy, risk and reward profile, charges, past performance, and practical information.
Few would argue with the KIIDs’ objectives and the need to replace the often far from simple Simplified Prospectus, and on the surface it should not be too taxing to achieve those goals. However, as with many things, appearances can be deceptive and a significant mini industry has developed across Europe as fund management companies, fund platforms and service providers all grapple with myriad issues associated with interpreting and applying the KIIDs requirements.
Keeping Up with the KIIDs
Firstly, let’s consider the timing. While most countries, including the UK, are proposing to grant a 12-month transitional period, new funds must publish a KIID on launch, thus creating a potential challenge of producing KIIDs for some funds and Simplified Prospectuses for others. Thereafter, the documents must be updated and re-published annually within the first 35 business days of each calendar year, and throughout the year the content must be monitored and be subject to re-publication in the event of a material change.
Secondly, the print volumes involved quickly multiply and reach the tens of thousands for the houses with large fund ranges sold across Europe, because the KIID is the one official document that must be published in the language applicable to the market in which it is sold. Even though there is provision to reduce volumes by either choosing a representative share class or by publishing one KIID containing several share classes, both raise separate challenges in terms of justifying the use of one share class over another and continuing to present the information in a clear and accessible manner.
Thirdly, fund companies and platforms have to establish processes to ensure that the current version of each KIID is made available to investors before they make their investment decision. They must also provide copies of the documents to each relevant home and host country regulator.
And then we come to the content itself. A problem area that stands out is the objectives and policy statements, which often run to pages in a prospectus. Cutting these pages down to perhaps a third of a page, whilst remaining totally consistent with the prospectus, will be no mean feat.
The Risk of Oversymplifying Risk
But the most radical component is the new Synthetic Risk & Return Indicator (SRRI)--a new volatility-based measure aimed at providing a consistent and straightforward indication of each fund’s relative risk on a standardised scale of 1 – 7 giving rise to fears that a majority, and wide variety, of funds will cluster in a few of the medium to high bands without adequately distinguishing between the risks of different types of investments.
We at Morningstar are working together with many fund companies as they seek solutions to these challenges. We continue to look closely into the details of the UCITS IV Directive to support the industry as it progresses its preparations for the arrival of KIIDS later this year. Dr Paul Kaplan, Director of Quantitative Research with Morningstar Europe, is already looking into ways to potentially improve this standardised measure of risk. Read the first in a series of articles on the topic in How Does Market Volatility Impact Risk Measures?
This article first appeared in Investment Adviser.
