Do Callable Corporate Bonds Constitute PRIPs?

In my latest article, available on SSRN, I discuss the application of Regulation (EU) No 1286/2014 ‘on key information documents for packaged retail and insurance based investment products (PRIIPs)’ to callable corporate bonds. The objective of this Regulation is to improve transparency for retail investors in relation to a wide variety of packaged retail and insurance-based investment products (PRIIPs). To this end, the regulation lays down uniform rules on the key information document (KID) that PRIIP manufacturers must provide to ‘retail investors’, in order for them to understand and compare the key features of investment products and the risks they entail.

Firstly, I present the main aspects of the Regulation relevant to the subject discussed. Two points are of primary importance:

(a) The first is the definition of the term PRIIP. It consists of two elements: ‘packaged retail investment products’ (PRIPs) and ‘insurance-based investment products’. In order to be considered a PRIP, an investment product must fulfil three conditions.  The first is that it must be provided to retail investors.  The second is that it must be ‘packaged’. Third, the amount repayable to the retail investor must be subject to fluctuations resulting from an exposure to one of two factors: reference values (such as indices, indexes) or the performance of one or more assets not directly purchased by the retail investor. This definition leads to two additional remarks:

(i) The notion of ‘packaging’ is not defined by the Regulation, nor is there any specific provision to this effect in the recitals. Only a reference to the deliberations preceding the Regulation’s enforcement could help cast light on the precise boundaries of the notion.

(ii) As far as the third condition is concerned, in the case of a PRIP, fluctuations per se of the amount repayable to the investor are not sufficient. When the amount repayable to the retail investor is subject to fluctuations due to the performance of one or more assets, these assets should ‘not be directly purchased’ by the retail client. In cases where the retail investor directly holds an asset, the above condition is not fulfilled. The considerations in recitals (6)-(7) of the Regulation clarify this aspect further.

(b) The second point is related to the Regulation’s material scope. Article 2(2) provides a list of products explicitly excluded from the Regulation. However, investment products that are not included in the list should not automatically be considered PRIIPs. Therefore, it is a matter of interpretation, on a case-by-case basis, whether a product which is not listed should be considered a PRIIP. It should be noted that, so far, no further clarification has been issued by the European Supervisory Authorities or the European Commission in this respect. In any case, the specific terms of each investment product not included in the list of Article 2(2) will need to be taken into consideration before determining whether it is a PRIP or not.

Secondly, in order to support my case, I take into consideration the discussions leading to the final approval of the Regulation, starting from as far back as the initial working process for its adoption. This exercise reveals that both the Commission and the predecessors of the European Supervisory Authorities (i.e., CESR, CEBS and CEIOPS) focused on three elements: packaged products, investment products with specific features concerning the determination of the repayable amount, and indirect holding of assets by investors. In addition, it proves that the European Parliament attempted to extend, in a significant way, the scope of application of the Regulation by proposing, inter alia, the replacement of the term ‘PRIP’ by the term ‘investment product’, which in its view would lead to the coverage of a substantially wider range of products than those laid down in the Commission’s Proposal (and finally covered by the Regulation as adopted). Nevertheless, the Parliament’s proposal was rejected and hence the term PRIP is defined in a narrower sense than envisaged by the Parliament.

Finally, in exploring whether the PRIIPs Regulation is applicable to callable corporate bonds, I reflect on the definition, the different forms, and the risks associated with these financial instruments. I conclude that the conditions laid down in the Regulation, with regard to the definition of the term ‘PRIP’, are in principle not fulfilled for two reasons:

(a) Firstly, there is no packaging whatsoever of a callable corporate bond, since the retail investors/bondholders are not exposed to underlying financial assets in a packaged form.

(b) Secondly, even if a callable corporate bond traded on the secondary market is subject to fluctuations - and thus, the amount repayable to the investor is also subject to fluctuations - this is not  sufficient to be qualified as a PRIP. Indeed, according to the definition of PRIPs, fluctuations of the amount repayable to the retail investor should result from an exposure either to reference values or to the performance of one or more assets which are not directly purchased by the retail investor. This condition is not fulfilled in the case of callable corporate bonds, since the causal link is missing: fluctuations are not related to any reference value (which does not exist), and the bondholder has a direct holding of the transferable security it purchases. Hence, despite the fact that callable corporate bonds are not explicitly excluded from the scope of the Regulation, they are not covered by the definition of PRIPs. They are nevertheless subject to provisions of the MiFID II governing the treatment of complex products.

Christos V. Gortsos is Professor of Law at the National and Kapodistrian University of Athens.