Insights
PRIIPs arrival pricE:
How to ensure compliance and minimise reputational risk
In recent decades, fund managers and administrators in the EU have had to navigate a swathe of new regulation, covering both UCITS and alternative investment funds (AIFs), that has primarily aimed to increase both transparency and investor protection.
This has not only put pressure on resources and costs, but failure to comply with the rules can also result in reputational and financial risk. The Packaged retail and insurance-based investment products (PRIIPs) regulation demonstrates this perfectly.
One of the central components of the PRIIPs regulation is the need for UCITS funds sold in the EU to provide retail investors with a key information document (KID), to help them understand the key features, risks, reward and costs of their investment product. Investors can use it to compare products, and the information it contains may be the key factor in their decision to invest in one fund over another.
If the KID provides incorrect or potentially misleading information, the consequences for the fund manager or administrator can be severe.
Take a fictional investor who has a range of funds to choose from. That investor is risk averse, so chooses a fund with the lowest risk indicator in the KID. Two years later, the fund has fallen significantly in value, and it is revealed in the financial press that the information in the KID was incorrect and the risk profile should have been much higher.
The investor (and any other affected investors) may then choose to take legal action to recoup their investment. This could result in the fund, its manager and administrator suffering serious reputational and financial damage, while also potentially being subject to regulatory penalty.
Clearly, ensuring that the KID is accurate at all times is absolutely critical.
Changes to PRIIPs regulation
Not only must the KID be updated on a regular basis, but the challenge for administrators and managers is made more complex by the fact that regulation can often be amended, creating new rules that have to be complied with.
The change to PRIIPs regulation that came into force on 1 January 2025, which relates to arrival price calculation, is a prime example.
A key part of the KID covers the transaction costs incurred by the PRIIP. These include both explicit costs (all expenses linked to management of the fund and the fees linked to the transactions), as well as the implicit costs (‘hidden’ costs linked to transaction fees).
These costs must be calculated on an annualised basis, based on an average of the transaction costs incurred in the preceding three years – meaning that for a report in 2025, the fund will need to use the transactions from 2022, 2023 and 2024 to calculate the average transaction costs.
Prior to the change on 1 January 2025, there were two methodologies available for the calculation of implicit costs:
· The highly simplified, so-called ‘New PRIIPs’ methodology, which uses standard half-spread tables (bid-ask spread) as the primary input.
· The arrival price, which involves calculating the percentage difference between the market mid-price at order time and its execution price.
From 1 January, however, funds in scope (with more than three years of history) can no longer use the New PRIIPs methodology and must use the arrival price methodology, along with the requirement to capture three previous years of transaction costs.
What are the risks of non-compliance?
As with much EU regulation, compliance with the PRIIPs arrival price calculation comes at a potentially high cost with no obvious return. It’s a regulatory-driven exercise that many will view as just a box-ticking exercise. If the funds you run or administer are in-scope, however, it’s absolutely essential that the boxes are ticked 100% correctly.
The purpose of the KID is to provide investors with accurate and complete information. If you don’t calculate the arrival price properly, using intraday market data, then you run the risk of providing incorrect or non-compliant information. All of which can potentially have severe consequences.
Firstly, there is a risk of financial penalties being imposed by regulators linked to the provision of ‘misleading information’. Far more damaging, however, is the direct financial and reputational risk that could result from a detected breach of the rules.
Sanctions available to the regulators can include orders suspending or prohibiting the marketing of a PRIIP and a public warning. In such cases, it’s likely that any action taken would be published in the financial media. The ramifications of this could be two-fold. Investors and consumer organisations may well decide to take action to recoup their investment, as shown in our earlier example, and in-flows into your fund may suffer.
It’s also essential to note that PRIIPs regulation applies across Europe. If a regulator in one country examines a KID and finds a fault, this may well be noticed in other jurisdictions. So, this is not just a local risk, but rather an EU-wide risk.
What are the challenges for in-scope funds?
The most significant challenge for many funds will be around data. The onus for compliance with PRIIPs regulation may fall with the manager itself, but in many instances will fall with the fund administrator or relevant management company (ManCo).
In order to comply with the new rules, there are two key data collection issues:
· The fund must capture all the relevant information for all transactions, including the timestamps for the order and execution time.
· The fund or administrator must then acquire all the necessary market data to calculate the arrival price accurately. This involves buying and processing intraday prices – which isn’t standard practice for the buy-side industry – as well as implementing model valuations for intraday and end-of-day historical data.
The regulation also covers instances where timestamps aren’t available for some trades. In this scenario, it allows a fallback method that uses the opening price of the instrument on the day of the transaction or the previous day's closing price as the arrival price. However, this method can only be used in exceptional circumstances and not as a general practice.
For these transactions, the fund must provide documentary evidence that it has made a reasonable effort to obtain the data without success. In addition, the use of opening or closing prices can be inaccurate and result in very high transaction prices due to intraday volatility.
Ultimately, calculating the arrival price creates three operational challenges:
· Systems. Many funds or their administrators won’t have systems in place to capture the relevant data – either for the trades or for the market prices. And even once they have the data, they need a system to make the necessary calculations, which are intensive.
The calculation for liquid, tradable prices, while using heavy computation, is relatively straightforward, but when it comes to derivatives or so-called over-the-counter (OTC) trades, model pricing is required, which is far more complex. And all this needs to be done historically (intraday) for three years, because the average needs to be calculated on a three-year basis.
· Resources. Managing all of this can be very work-intensive, especially if a large number of trades are involved. Many funds and administrators would need to take on extra resources to handle the additional workload.
· Costs. Unsurprisingly, the implementation of new systems and additional resources comes at a cost, in an industry where margins are already being squeezed. What's more, the collection of intraday market data required for accurate reporting comes at a higher cost, as there are very few market data vendors that can provide good coverage of high-quality intraday data.
It’s evident from all the above that funds or administrators choosing to manage this process on their own will face with a considerable administrative burden which will have significant cost implications.
What is the solution?
As with implementing changes to other fund regulations, it's not uncommon for firms to hesitate before deciding what processes to put in place. Some are waiting to see what their peers are doing and want to see a successful project that they can use as a reference for their own PRIIPs compliance.
Kicking the can down the road, however, is no longer an option because the rules are in force and compliance with arrival price calculation going forward is mandatory.
Given the complexities (and risks) involved, there is a strong case for partnering with a third party that can provide an accurate and cost-effective transaction cost process and arrival price calculation to ensure KID accuracy.
Considering the risks associated with non-compliance, it is a solution that can give you valuable peace of mind.
PRIIPs arrival price compliance with Value & Risk – validated by PwC
At Value & Risk, we have an all-in-one turnkey solution, validated by PwC, to help ensure compliance with the arrival price calculation methodology.
We have state-of-the-art infrastructure and access to all relevant market data for liquid instruments through a licensing agreement with the world's leading market data providers, ensuring the quality of data required for efficient calculation. We also offer model-based solutions for virtually all illiquid instruments and complex structures.
All we need from you is three years of transaction data, and we will set up the models and calculate the relevant arrival price. A fully quality assured report is then returned so that the KID can be updated with the guarantee that the regulation has been met.
Valuation and transaction analysis is at the heart of what we do. We guarantee a robust methodology, verified and validated by PwC, which is the only one of its kind in the market.
You can rely on the full support of our experienced valuation experts throughout the process, including set-up, processing, reporting and expert audit support.
