DISC 5 Risk and return information

The risk and return information comprises the following, to be prepared in accordance with the requirements of this section:

1. (1) the consumer composite investment's risk and return score and a narrative explanation of it;
2. (2) a narrative explanation of any materially relevant risks to the value, performance or investment returns of the consumer composite investment;
3. (3) any applicable risk warnings or statements required under this chapter; and
4. (4) the additional risk and return information as set out in DISC 5.8.

A manufacturer must calculate the risk and return score for the consumer composite investment or for each underlying investment option of a multi-option consumer composite investment by:

1. (1) following the applicable methodology in DISC 5.1.3R to produce an initial score, and then
2. (2) adjusting the score where appropriate and in accordance with DISC 5.6.

1. (1) Subject to (2) and (3) as applicable, the manufacturer must calculate an initial score for the consumer composite investment in accordance with the volatility calculation methodology set out in DISC 5.2 and the ranking in DISC 5.4.
2. (2) For a consumer composite investment which is a structured product, the manufacturer must calculate an initial score in accordance with the volatility calculation methodology set out in DISC 5.3 and the ranking in DISC 5.4.
3. (3) For a consumer composite investment to which DISC 5.5 applies, the manufacturer must identify the applicable pre-set initial score in accordance with that section

1. (1) A manufacturer must identify and prominently disclose as part of the risk and return information in DISC 5.1.1R(2) any material risks which are relevant to the consumer composite investment in addition to volatility.
2. (2) The risks in (1) include, in particular and as applicable to the consumer composite investment:
   1. (a) credit or counterparty risks;
   2. (b) operational risks (for example, relating to the safekeeping of assets);
   3. (c) the impact of any transactions in derivatives or forward transactions;
   4. (d) the use of leverage;
   5. (e) a fixed investment term or a forced disinvestment timeframe that does not allow the investor to ride out unfavourable market conditions; or
   6. (f) any other significant risk factor which could be materially relevant to the performance of or return on a consumer composite investment, including any factor not transparent to the market.

1. For the purposes of this section, a consumer composite investment's volatility track record:
2. (1) is data comprising the weekly pricing information or, if such information is not reasonably obtainable, monthly pricing information for:
   1. (a) the past performance of the consumer composite investment itself via its performance information;
   2. (b) the simulated past performance of the consumer composite investment, calculated on the basis of the historical values of the relevant underlying or reference assets; or
   3. (c) the past performance of an appropriate benchmark, meaning a benchmark with a reasonably similar investment mandate, investment objectives or strategy, and underlying or reference assets as the consumer composite investment; and
3. (2) covers a period of 10 consecutive years, ending on a date no earlier than 60 days before the date the manufacturer prepares or reviews (for the purposes of DISC 3.2.2R) a product summary for that consumer composite investment.

Where the consumer composite investment has less than 10 years of past performance history, the manufacturer must simulate past performance for the remainder of the 10 year period unless it reasonably cannot do so, in which case, it may use an appropriate benchmark.

In gathering the data for the volatility track record, the manufacturer must ensure that:

1. (1) the pricing basis adopted for performance information in DISC 5.2.1R(1)(a) is consistent throughout the period in DISC 5.2.1R(2) and provides a fair representation of the performance of the consumer composite investment;
2. (2) the approach to simulating past performance in DISC 5.2.1R(1)(b), or to measuring the past performance of an appropriate benchmark in DISC 5.2.1R(1)(c), as applicable, is consistent throughout the period in DISC 5.2.1R(2) and provides a fair representation of the likely volatility of the consumer composite investment over that period; and
3. (3) where relevant, the data is appropriately adjusted to reflect inflows and outflows of funds from the consumer composite investment and the effect of any smoothing over the period in DISC 5.2.1R(2).

1. (1) The volatility of the consumer composite investment must be computed, and then rescaled to a yearly basis, using the following standard formula:

1. (2) The returns ( r _{f, t} ) in (1) are measured over T non-overlapping periods of the duration of 1/m years.
2. (3) This means m=52 and T=520 for weekly returns, and m=12 and T=120 for monthly returns, and where r̄ _f is the arithmetic mean of the returns of the fund over the T periods:

1. (1) For the purposes of this section, track record is data comprising the daily historical pricing information, or if such information is not reasonably obtainable, weekly or monthly historical pricing information, for the relevant underlying or reference assets of the structured product that covers a period of 10 consecutive years ending on a date no earlier than 60 days before the date the manufacturer prepares or reviews a product summary for the structured product.
2. (2) Where the consumer composite investment has less than 10 years of historical pricing, the manufacturer must simulate historical pricing for the remainder of the 10 year period based on an appropriate proxy reference index, benchmark, or reference financial instruments, unless it reasonably cannot do so.

1. A manufacturer is required to simulate the future performance of the product to produce a value at risk (VaR) measure by:
2. (1) using the track record to simulate the future performance of the underlying or reference assets of the product;
3. (2) simulating the future performance of the product by calculating the product payout value for each simulated performance of the underlying or reference assets in (1) and multiplying each payout value by the appropriate risk-free discount factor for the recommended holding period;
4. (3) determining the product’s value at risk (VaR) by reference to the 97.5-percentile worst discounted product payout value created in (2); and
5. (4) using the value at risk (VaR) of the product to calculate a value at risk equivalent volatility (VeV), using the following formula:

where T = the length of the recommended holding period in years

In simulating the future performance of the underlying or reference assets in DISC 5.3.2R, the manufacturer must use an appropriate bootstrapping (or other Monte Carlo-based) methodology to generate an expected distribution of prices or price levels from the track record, based on a minimum of 10,000 “samples” or simulations with replacement.

1. (1) The manufacturer must adjust the simulated distribution of daily returns to account for any difference between the mean of the simulated distribution and the current market forward price for the underlying or reference asset for the recommended holding period.
2. (2) In (1), the current market forward price is a function of the current risk free interest rates and dividend yields (or similar running costs associated with the underlying or reference assets) used in the construction of the simulated distribution.

The output of the calculation set out in DISC 5.2 or DISC 5.3, as applicable, must be used to compute the initial risk and return of the consumer composite investment by applying it to the following grid of annualised volatility intervals, reflecting the increasing level of risk carried by the consumer composite investment and its position in the volatility scale:

The following consumer composite investments must be assigned an initial risk and return score of at least 9:

1. (1) a contract for differences;
2. (2) a contingent convertible security;
3. (3) a derivative;
4. (4) a security issued by a venture capital trust;
5. (5) an investment in an Enterprise Investment Scheme;
6. (6) a consumer composite investment with a volatility track record (within the meaning of DISC 5.2.1R and DISC 5.3.1R) shorter than 5 years;
7. (7) any other consumer composite investment where any of the following factors apply:
   1. (a) the investment strategy involves the use of leverage to a degree where it significantly increases the investment risk;
   2. (b) the retail investor could lose more than they invest; or
   3. (c) the investment, or the underlying or reference assets, are priced less frequently than once a month.

If the consumer composite investment is a structured deposit, it must be assigned an initial risk and return score of 1.

1. (1) The manufacturer must assess whether a consumer composite investment's initial score produced in accordance with DISC 5.4 or DISC 5.5 (as applicable) would provide retail investors with a fair and accurate reflection of the overall risks of the investment.
2. (2) Following the assessment in (1), the manufacturer must:
   1. (a) upgrade the score, where its assessment is that the initial score may lead retail investors to under-estimate the risks of the consumer composite investment, having regard in particular to any material risks identified under DISC 5.1.4R;
   2. (b) downgrade the score, where DISC 5.6.3R applies and in accordance with that rule; or
   3. (c) treat the initial score as the finalised risk and return score, where in its view the initial score provides an appropriate and fair indication of the overall risks of the consumer composite investment.

A manufacturer should consider its obligations under DISC 3.1.2R in assessing:

1. (1) whether and how to adjust the initial risk and return score of a consumer composite investment in DISC 5.6.1R; and
2. (2) whether to include additional information in the product summary to assist retail investors in understanding the risks of the consumer composite investment.

1. (1) A manufacturer may cautiously downgrade the risk and return score of a consumer composite investment where the initial risk and return score is, in the manufacturer's considered judgement, likely to overstate the overall risks of the investment – for example, because the relevant period used for the volatility calculation included a period of extreme market anomalies.
2. (2) A manufacturer may downgrade the risk and return score of a consumer composite investment to a more significant extent where there is at least 90% capital protection under all market conditions, so as long as the ultimate risk and return score is an appropriate and fair reflection of all relevant risks, including in particular the counterparty risks applying to the investment.
3. (3) The manufacturer must take particular care to clearly document the rationale for any downward adjustment in the initial risk and return score of a consumer composite investment.

In the FCA's view, it will not normally be appropriate for a consumer composite investment to which DISC 5.5.1R applies to have its risk and return score downgraded following the manufacturer's consideration in DISC 5.6.1R.

1. (1) Where a consumer composite investment features low liquidity, a manufacturer must add +1 to the risk and return score in addition to any other change to the score following the assessment in DISC 5.6.1R.
2. (2 For the purposes of (1), a consumer composite investment has low liquidity if one or both of the following apply:
   1. (a) a retail investor is likely to face delay or added cost for encashing, selling, or otherwise exiting the investment; or
   2. (b) the consumer composite investment has a high degree of exposure to inherently illiquid assets, meaning it is a FIIA or another investment where 50% or more of the underlying assets or reference assets are inherently illiquid assets for at least three consecutive months in the last 12-month period, or are permitted to be under its investment objectives.
3. (3) Insofar as it might fall within (2)(b), a share in a fund is not to be regarded as having low liquidity if it is admitted to trading and regularly traded on a UK RIE, a UK MTF, or a recognised overseas investment exchange.
4. (4) The adjustment in (1) need not be made where the consumer composite investment's risk and return score is otherwise 9 or above.

If the consumer composite investment carries a risk that the investor could lose more money than they invested, it must be assigned a risk and return score of 10.

The finalised risk and return score for a consumer composite investment should be an integer number reflecting the initial score produced under DISC 5.4 or DISC 5.5 (as applicable) after any adjustments under this section.

The manufacturer must keep an adequate record of the calculation of the risk and return score as well as any subsequent adjustment or revision for a period of at least 5 years.

The risk and return score for the consumer composite investment must be presented clearly and prominently in the product summary on a horizontal linear scale of 1 to 10, in the manner shown:

The manufacturer should consider supplementing the presentation in the product summary of the linear scale in DISC 5.7.1R with a concise explanation of how the risk and return score was calculated and a narrative explanation of the limitations of the approach, including a statement or explanation to the effect that:

1. (1) historical data, such as is used in calculating the risk and return score, may not be a reliable indication of the future risk profile;
2. (2) the risk and return score shown is not guaranteed to remain unchanged and the categorisation may shift over time; and
3. (3) where relevant, a risk and return score of 1 may still involve a degree of risk to the original amount invested or to the returns the investor may receive.

1. The product summary must include the following additional information:
2. (1) a narrative explanation of the relationship between risk and performance and how the performance of a consumer composite investment impacts its risk and return profile;
3. (2) appropriate performance information, summarising in narrative form the main drivers of investment performance for the consumer composite investment and identifying those most likely to determine the outcome of the investment and other factors which could have a material impact on performance;
4. (3) a narrative description of the factors that increase the investment risk of the consumer composite investment;
5. (4) a brief explanation of the kinds of conditions whereby the consumer composite investment is likely to generate lower or higher returns, or lead to investment loss or gains;
6. (5) for a consumer composite investment with a material liquidity risk, a warning to this effect and a brief explanation of this risk;
7. (6) a brief description of what outcome the investor may expect when the consumer composite investment matures or is redeemed, sold or encashed under severely adverse market conditions;
8. (7) the following information:
   1. (a) whether any capital protection is available in respect of the consumer composite investment, including any conditions or limitations of such protection;
   2. (b) if the consumer composite investment is exposed to issuer risk or counterparty risk, an explanation of what happens in the event of the risk crystallising;
   3. (c) if the investor might lose more than they invested or otherwise be required to make additional payments, an explanation and warning of this risk; and
   4. (d) if the investor is exposed to the risk of losing more than the original sum invested in the consumer composite investment, an explanation and warning of this risk, including an explanation of any applicable limits to that liability;
9. (8) if applicable, an explanation regarding the use of gearing as part of the consumer composite investment's investment strategy, including an explanation of the extent to which this increases the risk of loss and the potential for gains, depending on market conditions and the rate of leverage;
10. (9) if applicable, a warning to the effect that the risk of the consumer composite investment may be significantly higher than the one represented in the risk and return score where the consumer composite investment is not held to maturity or for the recommended holding period;
11. (10) for consumer composite investments with low liquidity or that are not regularly priced, a risk warning to that effect and that it may impact the retail client's ability to redeem or otherwise exit their investment;
12. (11) for a consumer composite investment with features posing material challenges to the ability of the average investor to understand its risk/reward dynamics, mechanisms or profile, a risk warning to that effect and that this may impact the retail investor's understanding of the risk and rewards of the investment;
13. (12) if applicable, an explanation that the investment return of a consumer composite investment denominated in a currency other than pounds sterling will be exposed to exchange rate risk;
14. (13) for consumer composite investments with contractually agreed-upon early exit penalties or long disinvestment notice periods, a summary of the relevant underlying conditions;
15. (14) for a structured deposit, an explanation of the risk to the interest payable, including the main drivers of that risk; and
16. (15) any applicable risk warnings provided for in FCA rules.

An example of a risk warning in DISC 5.8.1R(15) is the risk warning in COBS 4.5.16R which is applicable to a consumer composite investment that is an investment in a FIIA.