No KIIDing Around
The recent £18m fine imposed by the UK Financial Conduct Authority for a number of compliance breaches, including mistakes made in Key Investor Information Documents (KIIDs), has made it clear that the regulators are not kidding around about compliance by Ucits. This is just the latest example of regulators taking the KIID very seriously, showing that even the smallest errors by fund managers can potentially result in severe fines and reputational damage.
It is a stark reminder that it is better for asset managers to spend more time and resources in advance to create a clear KIID, than face the potential ramifications of failing to meet the letter of the law.
The FCA has made it clear that there will be no light touch for anyone. While the documents are aimed to be understood and used by retail investors, it is not just retail Ucits that need to be diligent. The whole industry needs to learn the lesson of recent enforcement activity and ensure their KIIDs are as clear as possible.
The FCA action in this particular case has highlighted four specific areas that need extra attention: the detailing of specific investment techniques used by a fund, explaining the potential negative impact of these techniques, describing a fund’s use of leverage, and expanding on the KIID’s Synthetic Risk and Reward Indicator (SRRI) to include accurate and complete written narratives.
While it may seem obvious that including the full details of a fund’s strategy is an absolute must for a KIID, it is the level of disclosure that is significant. It is not simply a case of referencing techniques, or the kinds of financial instruments that are used, as this does not necessarily suffice as clear information. Much more detail is required.
Second, complete disclosure of both the positive and negative implications of the asset management techniques being used is needed to ensure compliance. This must include an explanation in simple terms of the factors that are expected to determine performance where hedging, arbitrage, or leverage are used.
For example, a KIID could be found to be misleading and unclear if it only emphasised the potential benefits of the use of complicated instruments such as derivatives, but did not cover all the possible downside risks.
Third, it is necessary to explain the use of leverage in greater detail. For example, it must be made clear if the use of derivatives could generate leverage which could mean that there is a likelihood of greater fluctuations in a fund’s net asset value (NAV), including the magnitude of losses, than if the NAV was not leveraged at all.
Finally, it is vital for fund managers to include a very clear written narrative to accompany the KIID’s SRRI. The SRRI is designed to be a numerical scale to allow investors to assess the risks of investing in the fund; however, the UCITS regulation stipulates that this must also be explained via a written description of the risks. Even if a fund’s SRRI shows a high rating of six or seven, indicating to investors that the product has a high level of volatility, it is still necessary to provide an appropriate and clear narrative.
Ultimately, when it comes to the KIID the devil is in the details. The standard and level of expected disclosure to investors expected under Ucits is high and therefore fund managers need to ensure that they are not accidentally breaking the rules, as appears to have been the case in this issue.
While the KIID will eventually be replaced as a document, for the time being it remains an important part of the fund management industry, regardless of ongoing political change in Europe. It is therefore advisable that everyone learns the lesson of the latest enforcement actions and that Ucits managers undertake a full review of all their KIIDs.
Those who fail to do so will likely find out that to their detriment that the regulators are taking compliance by Ucits very seriously indeed.
Mark Browne is a Partner of the Financial Services Group at Dechert LLP, an international law firm.