knowledge | 13 June 2019 |

Bonds and the PRIIPs Regulation

Whether or not the PRIIPs Regulation 1286/2014 applies to corporate bonds has been the source of considerable market uncertainty. In July 2018, the European Supervisory Authorities (“ESAs”) wrote to the European Commission (“Commission”) seeking further guidance on this issue. The Commission responded to this letter on 14 May 2019.

Background

The PRIIPs Regulation applies broadly to any packaged retail and insurance based investment product (“PRIIP”) where the amount payable to the 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 investor. An issuer of a PRIIP must publish a key information document (“KIDs”) describing key features of the relevant product, in order to enhance transparency and improve investor protection in the PRIIPs market.

It is not always clear when an packaged retail investment product (“PRIP”) is inscope of the PRIIPs Regulation. In particular, there is wide spread confusion regarding the application of the PRIIPs Regulation to certain corporate bonds which include commonly used standard terms and conditions such as make-whole call options, certain change of control puts, index-linked and capital features and interest rate step-up/down mechanics, caps and floors.

On 19 July 2018, the ESAs wrote to the Commission (here) seeking clarity on the application of the PRIIPs Regulation to corporate bonds. According to the ESAs, analysis in some Member States indicated that there had been more than a 60% reduction in the number and overall volume of low denomination issuance by non-financial corporates in the first quarter of 2018, compared to the first quarter of 2017. Moreover, retail investors were encountering difficulties in trading their bonds where these were issued before the introduction of the PRIIPs regime, with evidence of up to a 25% reduction in some secondary markets.

In their letter, the ESAs urged the Commission to provide detailed public guidance as a matter of urgency on which types of products and in particular bonds, fall within the scope of the PRIIPs Regulation. In this respect, the ESAs asked the Commission to confirm whether or not it agreed with an analysis, prepared by the ESAs, which considered the application of the PRIIPs Regulation to some of the main types of features of bonds and which was annexed to the ESAs’ July letter.

The Commission’s Response

In its response (here), the Commission refused to pass judgment on which categories of products should fall within or outside the scope of the PRIIPs Regulation, stating that:

the assessment as to whether or not a particular bond is a packaged retail investment product (PRIP) is to be performed on a case-by-case basis taking into account all the features of the relevant bond, regardless of its type or name.

The Commission goes on to state that, by virtue of point 1 of Article 4 of the PRIIPs Regulation, a bond made available to retail investors qualifies as a PRIP where potential or compulsory payment of either interest, principal or both, may vary due to its exposure to reference values or the performance of one or more assets which are not directly purchased by the retail investors. Consequently, when determining whether or not a corporate bond is a PRIP, it is necessary to ascertain whether the terms and conditions of the bond provide for different payments depending on a variety of pay-out events. The reason or purpose for which retail investors acquire the bond, such as speculation, risk management or hedging, is irrelevant for the purpose of this assessment.  According to the Commission:

even categories of bonds that could seem to fall outside the scope of the PRIIPs Regulation could still be based on contractual terms and conditions that would qualify those bonds as PRIPs. Therefore, it is neither feasible nor prudent to agree ex-ante and in abstract terms whether some categories of bonds fall under the PRIIPs Regulation or not. 

Comment

The European Commission’s refusal to give further guidance on which types of bonds fall inside the PRIIPs Regulation is disappointing.  The on-going lack of clarity around the definition of a PRIP and the significant sanctions that may apply in the event of a mischaracterisation means that some issuers are likely to continue to target their issues towards non-retail investors only, leading not only to reduced choice for retail investors but also increasing the cost to issuers of raising finance and reducing the diversity of the investor base. 

This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.

Key contacts