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The Application of the PRIIPS Regulation to Bonds
On 24 October 2019, the European Supervisory Authorities (the “ESAs”) – the European Banking Authority, the European Securities and Markets Authority and the European Insurance and Occupational Pensions Authority - issued a supervisory statement (the “Statement”) regarding the regulation for packaged retail and insurance-based investment products (Regulation (EU) No 1286/2014, the “PRIIPs Regulation”). The Statement is intended to promote a consistent application by national competent authorities (“NCAs”) of the PRIIPs Regulation and sets out:
(i) guidance regarding the types of bonds (and debt securities more generally) for which it is necessary to draw up a Key Information Document (“KID”), as defined in the PRIIPS Regulation, and
(ii) recommendations to NCAs.
In the view of the ESAs, uncertainty over the application of the PRIIPs Regulation to bonds has led to negative consequences for the functioning of bond markets, and access to these markets by retail investors. The ESAs’ Statement is based on analysis conducted by the ESAs and by NCAs since the start of 2018 and follows an exchange between the ESAs and the European Commission.
The PRIIPs Regulation provides that a PRIIP is an investment product "…where, regardless of the legal form of the investment, the amount repayable to the retail investor is subject to fluctuations because of exposure to reference values or to the performance of one or more assets which are not directly purchased by the retail investor". The annex to the Statement provides guidance on the scope of the PRIIPs Regulation as it applies to different types or features of debt securities. The guidance states that each different type of debt security or feature must be considered individually and where a debt security combines different features, each feature needs to be considered separately.
According to the guidance, a debt security’s containing a “perpetual” feature, a “subordinated” feature or a “fixed rate” feature (includes zero coupon securities and securities with pre-defined step-ups and/or step-downs in the interest rate at fixed times) does not, of itself, imply that the debt security falls within scope of the PRIIPs Regulation.
The assessment of variable or floating rate securities depends on their specific features. Pre-defined rate increases which are not linked to a reference value or to the performance of specified reference assets do not result in a security being a PRIIP. This includes changes due to a ratings downgrade of the issuer, change of control event, or tax or regulatory event. Where there is a direct link to an interest rate index, this is considered to be a directly held asset and therefore still not a PRIIP, unless the security includes additional structuring that brings it within scope.
By itself, a “put” feature in a debt security does not imply that the debt security falls within scope. Neither does a “call” feature, although this may result in the debt security being within scope where the amount repayable at redemption is not fixed and fluctuation is caused by exposure to a reference value.
The inclusion of a provision that allows the issuer to pay off the remaining debt early using a reference rate to determine the net present value of future coupon payments that will not be paid (“make whole”) should result in the bond being a PRIIP. However, if all elements of the mechanism to calculate the discount rate are fixed in the terms and conditions of the security, then the make whole feature could be considered as not causing the security to be a PRIIP.
Finally, the guidance states that convertible securities are within scope of the PRIIPS Regulation.
The ESAs recommend that NCAs apply the guidance set out summarised above when supervising compliance with the PRIIPs Regulation.
Further, as part of their risk-based supervision, NCAs should monitor whether PRIIP manufacturers draw up and publish KIDs on their website for bonds that fall within the scope of the PRIIPs Regulation, and whether persons selling such bonds comply with the requirements in Article 13 of the PRIIPs Regulation. Where NCAs identify non-compliance with these requirements, they should take appropriate measures, including administrative steps in accordance with Chapter V of the PRIIPs Regulation.
The ESAs also recommend that during the upcoming review of the PRIIPs Regulation, legislators introduce amendments order to specify more precisely which financial instruments fall within the scope of the PRIIPs Regulation.