Last week, the Technical Committee of the International Organization of Securities Commissions
(IOSCO) issued a consultation paper on the distribution by intermediaries of complex financial products to retail and non-retail customers. The paper focuses on customer protections, proposing nine principles governing suitability and disclosure obligations, and will carry much weight as jurisdictions and IOSCO member regulators design or strengthen their regulatory regimes governing complex securities.
For purposes of the paper, distribution is defined broadly and functionally. IOSCO has defined the term to include: "the services of selling by the intermediary in its role as such including, in connection with that selling, advising, recommending and managing discretionary accounts/individual portfolios, which results in holdings by investors of complex financial products."
IOSCO has also broadly defined "complex financial instruments" to encompass every kind of financial product outside the most vanilla instruments:
Complex financial products – refer to financial products, whose terms and features are not likely to be understood by an average retail customer (as opposed to more traditional or plain vanilla investment instruments), where these products have a complex structure, are difficult to value (so that their valuations require specific skills and/or systems) and/or have a very limited or no secondary market (and are therefore potentially illiquid). The term generally includes, but is not necessarily limited to, structured instruments, credit linked notes, hybrid instruments, equity linked instruments and instruments whose potential pay-off is linked to market parameters, asset-backed securities (ABSs), mortgage-backed securities (MBSs), collateralised debt securities, and other financial derivative instruments (including credit default swaps and covered warrants). The term does not include conventional equities, conventional bonds and exchange-traded standardised derivatives contracts. The said list is intended to be illustrative and non-exhaustive. The above criteria are proposed to be taken into account when determining the level of complexity of a financial product.
Finding that in most jurisdictions the suitability requirements complex financial instruments are for the most part the same as those for for more basic investments, creating dangerous regulatory gaps, the consultation paper lays out nine guiding principles for suitability and disclosure. The nine proposed principles broadly cover customer classification, disclosure and suitability requirements, protection of customers for non-advisory services, compliance function and internal suitability policies and procedures, incentives and enforcement.
In developing these draft principles, IOSCO took into account feedback from a number of industry associations representing market intermediaries and product providers as well as other organizations. The appendix to the report lays out in more detail some of the most important and revealing survey results. The appendix also provides succinct descriptions of how IOSCO members have chosen to regulate in the area of complex securities, and serves as a guide to how these regulatory strategies differ amongst the major markets and jurisdictions.
Comments on the consultation paper are due before Monday, May 12, 2012.