We already explained the Market Risk Measure (MRM) calculation for Category 2 and Category 3 PRIIPs in our last several blog posts. In this article we want to complete the explanation of the MRM calculation requirements by showing the MRM classification for Category 1 and Category 4 PRIIPs.
There are two possibilities for a PRIIP to be assigned to Category 1. In cases where the product is a derivative and / or the investor can lose more than the invested amount (e.g. futures contracts or options), the PRIIP is automatically considered to be Category 1 and the MRM classification is class 7.
The second possibility for a product to be assigned to Category 1 includes the assignment of the MRM class 6 and is valid for PRIIPs that do not meet the minimum data requirements (daily prices: 2 years, weekly prices: 4 years, bi-monthly or monthly prices: 5 years, while no representative benchmarks or proxies are available).
Category 4 includes PRIIPs which are completely or partly dependent on factors that cannot be observed in the market. Therefore the first step for the definition of the MRM class is to identify the different components that contribute to the performance of the PRIIP and to differentiate between the following characteristics and actions:
- PRIIP components that are wholly or partly dependent on factors observable in the market, are assigned to Category 1, 2 or 3 and handled according to their respective requirements.
- PRIIP components that are wholly or partly dependent on factors unobservable in the market, or require the usage of robust and well recognized industry and regulatory standards when it comes to the determination of relevant expectations. On the one hand, it is important to determine the future contribution of those factors but on the other hand the uncertainty that may come with this contribution needs to be part of the considerations as well.
After the differentiation of the Category 4 PRIIPs in detail, the Value at Risk- (VaR-) equivalent volatility (VEV) must be calculated for each of the components. Afterwards, the single component volatilities are weighted proportionally to define the overall VEV of the PRIIP.
With the VEV being calculated, the MRM class can be assigned. The assignment follows the same rules as for both Category 2 and Category 3 PRIIPs. The exact mapping can be found in our blog post about the MRM calculation for Cat 2 PRIIPs.
The calculation of the MRM brings us one step closer to the definition of the Summary Risk Indicator (SRI), which needs to be shown on PRIIP KIDs. The SRI is a combination of the Market and Credit Risk Measures. Therefore, we will explain further details about the Credit Risk Measure (CRM) in one of our next blog posts.
How will KIDs for PRIIPs impact your business?