Regulators warned about flawed Kids eight years ago

Regulators warned about flawed Kids eight years ago

Regulators were warned back in 2010 about the confusion that would be caused by the summary risk indicators in key investor documents (Kids).

Under the Packaged Retail Investment and Insurance Products (Priips) rules, investment trusts are required to produce summary risk indicators, which are designed to calculate and explain to investors the level of risk investment vehicles expose them to.

At present the rules apply just to investment trusts, but in 18 months time the rules will also apply to open-ended funds.

Last week in a 23-page paper, titled Call for Input: Priips Regulation – initial experiences with the new requirements, the FCA admitted the "SRI might, in some cases, be misleading."

The regulator stated this may be because either the risk of the product does not appear to be adequately captured by the SRI, or the product has a significantly different SRI from other economically equivalent products.

The FCA asked for examples of products where the prescribed methodology for assessing and presenting risk leads to a counter-intuitive or potentially misleading SRI.

But the Association of Investment Companies has argued it warned European regulators about the problems the FCA is now flagging with the SRI at the time it was putting the Priips rules together.

The summary risk indicator methodology requires product providers to calculate the risk level of the product based on a ranking of between one and seven, with seven the most risky and one the least risky.

Back in 2010, the Association of Investment Companies (AIC) notified European regulators: "The AIC disagrees that a risk rating be included in the Kid.

"This approach has the potential to misguide investors, and using the methods suggested, is an inappropriate basis for investor decisions. Measuring risk by historic volatility is potentially misguiding for investors and can offer a false sense of security and certainty."

As FTAdviser has previously reported, the method designed at European level and endorsed by the FCA for calculating the level of risk is based on the volatility of the underlying assets, that is, the frequency with which the price of those assets move, rather than the capacity for loss to investors from those investments.

The trade body flagged this methodology means the venture capital trust (VCT) sector is currently showing up as the least risky AIC sector, with an average risk level of 3.4.

However many of the holdings in VCTs are companies that are not listed on any stock market, so as a result the pricing of the underlying investments held moves infrequently.

This mean VCTs are not measured under the summary risk indicator methodology as being particularly volatile.

The Investment Association, which represents the open-ended funds that will soon be covered by the rules in future, said: "Customers – and their advisers - need information that is reliable, clear and meaningful in order to make informed investment decisions.

"The Priips transaction cost methodology is a particular concern, given that it is also mirrored in UK defined contribution pension scheme disclosure requirements and underpins Mifid cost disclosures.