Ireland: The KIID - A Summary of the Requirements of the Key Investor Information Document

Originally published 10^th February 2011

One of the key provisions of the UCITS IV Directive, which was approved by the European Commission on 13 January 2009, is the implementation of the key investor information document ("KIID"). This document replaces the simplified prospectus which was required pursuant to the UCITS III Directive and which was seen to have a number of shortcomings.

The KIID is to be a short document containing key investor information the aim of which is to facilitate retail investors' understanding of the product being offered. It is intended to allow direct comparisons to be made more easily between UCITS funds. This briefing sets out the requirements relating to the KIID.

Reasons for the KIID

The aim of the simplified prospectus was to provide investors with a short document which would distil the pertinent details about a UCITS taken from its prospectus. It soon became clear that the objective that this document was intended to achieve was "lost in translation" in more ways that one. First, certain EU Member States imposed their own content requirements in relation to the document, hindering the ability to make comparisons between funds. Secondly, the time it took to prepare and update was significant and costly. Also, the nature of the disclosures required in the document meant that for UCITS with multiple sub-funds and multiple share classes what was meant to be a short document became a lengthy one. In some cases the simplified prospectus runs to over 10 pages in length. Also, notwithstanding the fact that the simplified prospectus often may be lengthy, detail about the real costs of investing in a fund and the risks of investing are not clearly identified in the simplified prospectus.

The purpose of the KIID is to seek to avoid these problems and create a uniform document that will communicate all relevant and pertinent information about a UCITS to investors. It is intended to enhance transparency and comparability through the use of a short and standardised fact sheet.

The European Commission engaged with the Committee of European Securities Regulators ("CESR") to determine the essential matters that must be included in the KIID. CESR issued technical advice to the European Commission on the level 2 measures relating to the format and content of KIID disclosures for UCITS. Summarised below are CESR's recommendations and an explanation of some of the differences between the KIID and the existing simplified prospectus regime.

The form of the KIID

Language Used

As the KIID is aimed at retail investors, the language must be written in a concise manner, in non-technical language and presented in a way that is likely to be understood by retail investors. It must be fair, clear and not misleading and must be consistent with the relevant parts of the prospectus. It should consist only of the kind of information that potential investors need to make an informed investment decision. CESR recommends that a UCITS should follow general good practice guidelines about clear language and layout and suggests, for example, that the Oxford Guide to Plain English, or the Plain English Handout prepared by the US Securities & Exchange Commission should be considered when preparing the KIID.

Size

In order to address the fact that the simplified prospectus has become a lengthy document the size and content of the KIID is now prescribed. It cannot exceed a double-sided A4 sheet (although for structured UCITS funds which are more complex three sides of A4 sized paper are permitted). CESR's guide to clear language and layout for the KIID goes so far as to suggest the type and size of the font to be used and suggests sentences should not exceed 25 words.

Translations

The KIID must be issued in the official language, or one of the official languages of the UCITS host member state, or in a language approved by the competent authorities of that member state. No amendments may be made to the KIID to reflect country specific information unlike the simplified prospectus which often was amended to reflect local requirements.

Timing

The simplified prospectus must be offered to an investor before the conclusion of contract. The KIID must be provided "in good time" before an investor subscribes for shares.

The content of the KIID

Objectives and investment policy

A short description of the essential features of the investment product must be described in the KIID - even if the features do not form part of the investment objectives and policies - so as to ensure that a balanced description of the objectives and investment policies is provided to investors. It must describe the main categories of eligible financial instruments, detailing any industrial, geographical or other focus. Unlike the existing simplified prospectus format, this section must include a statement that investors may redeem on demand and it must disclose whether dividend income is distributed or reinvested (a separate section relating to the distribution policy which appears in the simplified prospectus will no longer be included).

Risk and reward profile

The simplified prospectus must include a brief and easily understandable description of all relevant and material risks associated with the investment policy of the UCITS. The KIID must provide information on the risk profile of the investment, including appropriate guidance and warnings in relation to the risks associated with investment in the UCITS. It must give a fair and balanced description of the likelihood of growth or loss. CESR recommended that the KIID include a synthetic risk and reward indicator ("SRRI") in the form of a numerical scale. The SRRI will correspond to an integer number designed to rank the fund over a scale from 1 to 7, according to its increasing level of volatility/risk-reward profile, and is based on defined annualised volatility intervals. The SRRI must be supported by a narrative explanation of the limitations of the indicator and the other material risks relevant to the UCITS which are not, or not fully, captured by the methodology for the synthetic indicator (such as credit, counterparty, liquidity and operational risk).

The general methodology for calculating the SRRI proposed by CESR is based on historical volatility. Volatility is to be estimated using the weekly past returns of the fund (or monthly if the NAV is calculated less frequently). Returns are to be gathered from a sample period covering the last five years of the life of the fund and, in case of distribution of income, shall be measured taking into account the relevant earnings or dividend payoffs. However, for structured UCITS, the methodology is to be based on volatility as computed through reverse engineering from a value-at-risk (VaR) measure.

Notwithstanding CESR's recommendations on the risk/ reward indicator the European Commission has decided not to include CESR's proposals in relation to the general methodology for calculating the SRRI in the UCITS IV Regulations. The European Securities and Markets Authority ("ESMA") (which comprises a group of experts advising on the future of European financial regulation and supervision and which replaced CESR in 2011) will have the power to impose guidance across member states and will be engaged to develop "binding technical standards" for the methodologies. The intention is that these standards can then be adapted more easily to ensure the information on the risk profile of the investment is accurate.

Description of the costs and charges

The simplified prospectus requires a distinction be made between those fees paid directly by investors (such as subscription and redemption charges) and those fees paid out of the UCITS assets (for example, the annual management fees). For the KIID a table must be included setting out the different elements of the charging structure and a brief narrative explanation of each of the charges. The table should disclose any one-off charges payable before or after an investor invests and the ongoing charges taken from the fund over each year. The ongoing charge is a single figure encompassing all annual charges and other payments out of the fund's assets (excluding performance fees, which must be disclosed separately).

CESR proposed a methodology for the calculation of the ongoing charge and listed the charges which are to be included in the ongoing charge. They include payments to the service providers, registration fees, regulatory fees and similar charges, audit fees, legal fees and any costs of distribution. Those fees and costs that are excluded from the ongoing charge are entry and exit charges or commissions, performance-related fees, interest on borrowings and payments incurred in connection with the acquisition or disposal of assets. As with CESR's proposals in relation to the general methodology for calculating the SRRI, the European Commission has decided not to include CESR's proposals in relation to the methodology for the calculation of the ongoing charge in the UCITS IV Regulations and instead it is proposed that the ESMA develop binding technical standards for the methodology.

There is no requirement to include a total expense ratio or portfolio turnover rate in the KIID as is currently required for the simplified prospectus. The total expense ratio is based on total operating costs taken from the audited accounts for the relevant fiscal period for the UCITS and proved to be problematic as the methodology used to calculate the total expense ratio had to be validated by the auditors of the UCITS.

CESR has recommended that performance figures relate to the calendar year. The UCITS will be under an obligation to ensure the figures used which will be unaudited as at calendar year end are fair, clear and not misleading. In the simplified prospectus, performance data was generally prepared by reference to the UCITS fiscal year end to link in with the need to provide total expense ratios using audited information. However, to assist the direct comparison of performance data between funds the performance information must be prepared for the KIID to the end of each calendar year. Past performance must be updated annually. The KIID must be published no later than 35 business days after 31 December each year with updated performance data.

The UCITS must establish procedures to ensure that the charges figures disclosed in the KIID are kept under regular review. The accuracy of the ongoing charges must be reviewed at least annually. Any 5% change to any charge requires an update to the KIID. This will require ongoing monitoring of the fees and expenses to ensure that the fees disclosed remain fair, clear and not misleading and that there are no deviations from the disclosed charges which will require an update to the KIID.

The UCITS IV Regulations require structured UCITS, such as capital protected and other comparable UCITS, to use prospective performance scenarios in place of past performance information. CESR has issued guidelines on the selection and presentation of performance scenarios for a structured UCITS with a view to harmonising these scenarios.

Presentation of past performance

Similar to the existing simplified prospectus procedures, a bar chart displaying up to 10 years performance in percentage terms (including the performance of a benchmark if referred to in the investment objective or policy) must be included in the KIID. Where a UCITS has a track record of less than five complete calendar years a template with slots for the last five years must be included with blank slots used for any year for which data is not available.

In certain other special situations/circumstances (such as material changes in the investment objectives and policies during the performance period, mergers through absorption or changes in legal status of the UCITS) subject to certain disclosure requirements, it may be possible to retain/include performance from periods prior to the change.

Practical information, including details of where and how to obtain additional information

The usual information about relevant service providers is to be included in the KIID.

Particular Structures

Umbrella UCITS

A separate KIID must be produced for each individual sub-fund. Where a UCITS consists of more than one class of shares, a KIID must be prepared for each class. However it is possible to select to use a "representative class" based on the characteristics of the fund, the nature of the differences and range of choices on offer.

The selection of the "representative class" must be fair, clear and not misleading and the risk and reward profile must set out risks applicable to the other share classes. The management company must keep a record of the share classes represented by the "representative class" and the grounds for justifying the choice, which will present additional compliance monitoring to ensure that the "representative class" remains fair, clear and not misleading.

While the UCITS IV Regulations permit the use of a representative class, it would appear the promoters with UCITS comprising a significant number of classes within numerous sub-funds intend to prepare KIIDs on an individual share class basis and not rely on a "representative class". Taking into account the need to prepare translations of the KIID, this may lead to a significant number of KIIDs being prepared for each UCITS.

Particular requirements exist in relation to structures with fund of funds, structured funds and capital protected funds.

Durable Medium

The KIID must be provided in a durable medium (which means either a hard copy, floppy disc, CD-ROM and DVD) or by means of a website. The provision of the KIID by durable means or on a website must be appropriate in context of the business conducted between the management company and investor. If the KIID is to be provided via a website the investor must specifically consent to this and be notified of the web address. A hard copy of the KIID must be delivered to investors on request, free of charge. An up-to-date version of the KIID must be available on the website of the investment company or the management company.

Updating

The essential elements of the KIID must be kept up-to-date. The KIID can be updated as frequently as a UCITS wishes however, it must be updated (a) prior to or following any material change; (b) prior to a proposed change to the fund rules, instrument of incorporation or prospectus; or (c) at least annually, and within 35 business days of each calendar year end, to reflect the updated past performance information.

Effective Date

Although the implementation date for UCITS IV is 1 July 2011 a special transitional provision is provided for in the UCITS IV Directive in relation to KIID, allowing UCITS to replace their simplified prospectus with the KIID within a further 12 months from this date. However, Member States when implementing the UCITS IV Directive into their national law and regulations can decide whether to allow a UCITS established in that Member State this additional time to implement the KIID. Certain jurisdictions (such as Germany) have already indicated that their implementing legislation will not provide for such transitional provision. Notwithstanding this, a host Member State cannot restrict the rights of a UCITS to use the simplified prospectus if its home Member State allows a transitional period. This applies irrespective of whether the UCITS is already accessing the marketing of a host Member State as at 1 July 2011 or they begin to do so subsequently (but before the 1 July 2012 deadline). The UCITS must always provide the same type of document (whether the simplified prospectus or the KIID) to investors in the UCITS home Member State and in every host Member State in which it is notified.

Conclusion

The aim of the KIID is provide a simpler document for use by investors notwithstanding the fact that in many respects the requirements in relation to the KIID are more detailed than the current simplified prospectus regime. While the ability to circulate the KIID in a durable medium or by means of a website will result in cost savings, the continual review of ongoing charges and the risk and reward element may prove onerous from a compliance perspective. Similarly, the requirement to produce a KIID on a per sub-fund and per share class basis will be costly and time consuming.

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.