In the constantly changing financial world, regulatory compliance occupies a central place for companies offering investment products to their clients. The European Union (EU) introduced the PRIIPs (Packaged Retail and Insurance-Based Investment Products) regulation with the aim of increasing the transparency and understanding of financial products for retail investors. At the heart of this regulation is the creation of the KID (Key Information Document), an essential document summarizing the main characteristics of a financial product. In this article, we will dive into the details of KID PRIIPs and analyze how artificial intelligence (AI) is transforming KID compliance for PRIIPs.
What is the KID for PRIIPs?
Applied from January 1, 2023, any packaged financial product marketed to retail customers, must have a key information document (key information document, or KID) in its PRIIPs form (PRIIPS stands for Packaged Retail Investment and Insurance-based Products). The requirement affects virtually every player in the European financial market-from banks and fund management companies to insurance providers.
The Key Information Document applies to all “packaged” retail investment products. This includes any insurance linked products as well as mutual funds, (FCP’s and SICAV’s), Real Estate Investment Companies (SCPI), investment contracts and any unit linked offering. Packaged means any publicly marketed financial product that has exposure to underlying assets—stocks, bonds, etc.—that provide a return over time, and have an element of risk. This essentially covers all packaged retail investment products marketed in the European Union, including insurance policies.
Products classified as “non-packaged”, such as simple shares held in a securities account or a Stock Savings Plan (PEA), are not subject to the KID requirement. .
Some concrete Examples of PRIIPs Products
Investment Funds: Mutual funds (FCP), real estate investment funds (SCPI), and exchange-traded funds (ETF) are examples of PRIIPs. Investors buy shares of these funds, and their return depends on the performance of the underlying assets, such as stocks, bonds or real estate.
Structured Products: Structured products, such as certificates, variable yield bonds and structured notes, are also considered PRIIPs. Their returns are often linked to stock indices or other financial instruments.There are approximately 28500 structured products.
Options and Futures Contracts: Call and put options, as well as futures contracts on commodities, currencies or stock indices, are PRIIPs. Their values fluctuate based on movements of the underlying assets.
Life Insurance with Investment Component: Life insurance policies that have an investment component, such as unit-linked, are examples of PRIIPs. The profits paid to the holders of these policies depend on the performance of the underlying investments.
Insurance Products: Certain insurance products, such as investment-linked life insurance contracts, also fall into the category of PRIIPs because their return depends on the performance of the underlying assets.
In short, any product aimed at retail customers where their redemption amount varies depending on the performance of one or more underlying assets, such as stocks, indices or funds is considered a “packaged” product and thus falls under the KID for PRIIPS requirement.
Objectives of the PRIIPs Regulation
The PRIIPS regulation aims to ensure that retail investors benefit from clear and transparent information on products before making investment decisions. This is why Key Information Documents (KIDs) are required for each PRIIP, providing essential information about the product, risks and related costs. The KID must be provided before any subscription and provided when there is a change to the product. The principle is simple: no KID, no transaction.
The KID summarizes essential information about the product, including its nature, objectives, operation, risks and related costs. It makes comparing products easier for non-professional investors.
- This document must be written in the official language(s) of the country where the product is distributed.
- The content of the KID must be concise, clear, accurate and unambiguous. It takes the form of a standardized document of three pages maximum, clearly identifiable and distinct from any marketing material, such as brochures or leaflets.
- The KID must meet strict criteria both in substance and form. Each time a change impacts the financial product covered by the KID (such as costs or risk structure), a new KID must be issued to the retail investor.
KID Content uncludes:
- the main characteristics of the product (“What is this product?” section): the objectives of the product, the means implemented to achieve these objectives, the lifespan of the product, as well as a description of the type investor for whom the product is intended;
- what are the risks and what could be in return for me?;
- risk indicator: on a scale from 1 (the least risky) to 7 (the most risky);
- the maximum possible loss of capital;
- four performance scenarios: very unfavorable, and unfavorable, intermediate and favorable scenarios;
- the recommended holding period;
- expenses (direct, indirect, one-off and recurring costs).
Application of the Regulations and Consequences
The financial supervisory authorities in each EU country are responsible for ensuring that manufacturers of investment products comply with the KID regulations for PRIIPs.
Failure to comply with the KID PRIIPs requirements can range from being prohibited from marketing the PRIIP to receiving a significant fine.
Of course, the reputational damage can far surpass any fine as customers and investors lose confidence in organizations who breach regulations.
The Complexity of KID Compliance for PRIIPs
Creating and updating KIDs requires careful data management and complex process management. Product manufacturers like asset managers and distributors must collect all the required product information across the different vehicles and products impacted by the regulation. In many cases, these products are offered in different languages and so the KID must be produced in that language. They must also create the performance scenarios and indicators, create consistent risk evaluation criteria and holding period data to generate compliant KID documents. THEN, they need to monitor each product to determine if anything has changed that requires an update to the KID. If so, they have to process the update and redistribute the KID.
Needless to say, this process entails significant operational risks for organizations due to human error, product specifics and the details of the regulation itself.
The traceability, sourcing and use of information contained in the KID documents requires robust quality management across multiple source documents, for different types of products, offered to different investors and subject to different jurisdictional requirements or languages. And then the requirement to update the KID when there are changes to the product means all these criteria need to be monitored on a regular basis to remain compliant. A spreadsheet doesn’t begin to meet the need.
The stakes are high. Non-compliance poses the biggest threat to businesses.
Artificial Intelligence at the heart of KID Compliance
Artificial intelligence offers solutions to address these issues.
Artificial intelligence (AI) can play a critical role in KID PRIIPs regulatory compliance in several ways:
Data management: AI can automate the collection, processing and management of data needed for KIDs. It can extract relevant and consistent information from multiple data sources, improving the reliability and accuracy of the information provided.
Automated updates: Regulations are constantly evolving, requiring frequent updates of KIDs to reflect significant changes in product characteristics. AI automates this process by tracking regulatory changes and updating documents accordingly.
And as the products themselves change, AI can be used to ensure those changes are captured appropriately and updated KIDs are issued as required.
Reduction of errors: AI reduces the risk of human errors, ensuring the accuracy of the information provided in KIDs. This is crucial to avoid regulatory sanctions and preserve the reputation of the financial institution.
In summary, AI simplifies and improves the KID PRIIPs regulatory compliance process by automating many tasks and improving data quality. It makes it easier for financial institutions to meet evolving regulatory requirements while providing an improved customer experience.
Here is a video presentation on the KID PRIIPs offer in which artificial intelligence allows the automatic transformation of the KIID (DICI) into a KID adapted to PRIIPs regulations and the automatic generation of key information documents from financial documents.
AI: A Key Partner for the future of KID Compliance
By automating processes, AI reduces operational costs and the risk of non-compliance, thereby avoiding sanctions and reputational damage.
AI provides accurate data to make informed strategic compliance and investment decisions.
Businesses that adopt these technologies are better prepared to meet evolving regulatory requirements and deliver an enhanced customer experience.
On October 3, 2023, during AM Tech Day, OUTSCALE hosted a workshop, highlighting the successful implementation of the KID for PRIIPs solution at one of its clients. For more information, please refer here.
Overall, AI simplifies processes, improves information quality and helps businesses adapt to regulatory developments, making it a critical partner for the future of KID PRIIPs compliance.
Financial institutions that integrate this technology into their operations will be better positioned to thrive in an ever-changing regulatory environment.