PRIIPs methodology (Delegated Regulation (EU) 2017/653)
Delegated Regulation (EU) 2017/653 of March 8, 2017 sets how a PRIIP manufacturer computes and presents the risk, performance scenarios and costs shown in its key information document.
Regulation (EU) No 1286/2014 requires the key information document (KID); Commission Delegated Regulation (EU) 2017/653, adopted on March 8, 2017, says how to fill it in. Practitioners call it the PRIIPs RTS, and everything that gets calculated sits in its annexes. Annex II holds the risk methodology, Annex III its presentation, Annexes IV and V the performance scenarios, Annex VI the cost methodology. Risk is computed in three steps. The manufacturer first places the product in one of the four Annex II categories, based on the shape of its payoff and the price history available. From that it derives a market risk measure (MRM) from 1 to 7, built on a volatility equivalent to the 97.5% VaR over the recommended holding period: Cornish-Fisher for linear products, a bootstrap of at least 10,000 simulations for the others. It then grades the credit risk of the issuer or guarantor (CRM, from 1 to 6) from credit quality steps, adjusted for maturity. A table finally combines the two measures into a summary risk indicator (SRI) from 1 to 7, and credit can only push the market score up. Delegated Regulation (EU) 2021/2268 of September 6, 2021 recast the performance scenarios and the cost presentation, and also touched the risk indicator; originally due on July 1, 2022, it has applied since January 1, 2023, the date set by Delegated Regulation (EU) 2022/975. The Q&As of the three European supervisory authorities (JC 2017 49, then JC 2023 22) supplement the text, and are read as closely as the annexes. The usual criticism is that a single number from 1 to 7 sums up products whose distribution tails have nothing in common.
Textbook case: a category 2 equity fund, recommended holding period of 5 years, 60 observed monthly returns. Monthly volatility σ = 4.5%, skew μ1 = -0.6, excess kurtosis μ2 = 2.5, N = 60 periods. Cornish-Fisher terms: 0.474 × (-0.6) / √60 = -0.0367; 0.0687 × 2.5 / 60 = 0.0029; 0.146 × 0.36 / 60 = 0.0009. Bracket: -1.96 - 0.0367 - 0.0029 + 0.0009 = -1.9987. σ√N = 0.045 × 7.746 = 0.3486, so 0.3486 × (-1.9987) = -0.6967, minus 0.5 × 0.045² × 60 = 0.0608: VaR = -0.7575. VEV = (√(3.842 + 1.5150) - 1.96) / √5 = (2.3145 - 1.96) / 2.2361 = 15.85%. Between 12% and 20%, the MRM is 4. With a CRM of 1, an assumption of this example, the Annex II table leaves the SRI at 4.
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