Any standard risk rating for investment funds developed by European regulators must be refined to make it effective for consumers, says the Association of British Insurers (ABI) and the Investment Management Association (IMA).

The Committee of European Securities Regulators (CESR) has put forward its proposals for a standardised and reward rating methodology, which is now under consideration by the European Commission. The standard would be used when firms produce Key Information Documents (KIDs) for UCITS funds, and would be implemented from the second half of 2011.

However research released by the ABI and IMA shows that 70 per cent of asset classes that are rated using the proposed method in 2006 would have had the risk categories changed just three years later, and doubling the period of data leads to a significantly more reliable risk indicator. A change from five to ten years reduces the proportion of asset classes that would have their risk categories changed between 2006 and 2009 from 70 per cent to 20 per cent.

"Improving the way in which investment risk is explained to consumers has the potential to deliver significant benefits," explained Dr Rebecca Driver, director of research at the ABI. "The rules as proposed do not yet fully deliver that benefit. We hope the research work released today will help the Commission as it looks for the best solution."

The research also showed that under the proposed scale of seven risk categories, a third of asset classes and half of all funds would fall into one category alone. Therefore, the ABI and IMA say the boundaries should be adjusted to give a better spread across the categories, helping consumers to choose between funds.
Dr Julie Patterson, director of authorised funds and tax at the IMA, added: "Reducing investment risk to a single indicator for an individual is neither easy or a solution in itself to the complex investment decisions that consumers face. Our joint research shows how the workings of the proposed indicator could be improved to enhance significantly its usefulness to consumers."

Two reports, Note on CESR's recommendations for the calculation of a synthetic risk reward indicator (joint ABI and IMA research brief, Rebecca Driver and Julie Patterson), and Developing a risk rating methodology are available on the ABI and IMA websites.

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