The U.K.’s recent referendum to withdraw from the European Union has affected virtually all segments of the financial industry. The structured products area is no exception. Market participants are considering what responses, if any, are appropriate in their structured products offering documents as a result of this development.
In this article, we propose a framework for considering these issues. In particular, these developments impact both the disclosures that individual issuers make about their business and financial results, as well as disclosures specific to any given product and its underlying asset(s).
As is the case for any securities offering, the (yet unknown) impact of “Brexit” could have an impact on the issuer’s financial results and creditworthiness. Adverse changes in the issuer’s financial condition would impact the likelihood of repayment and the value of the product in question. Some issuers may be more affected than others by these developments. For example, one would expect issuers headquartered in Europe to be more likely to be affected than their North American counterparts. In addition, some North American issuers may be more exposed to developments in the European markets than others, whether as a result of where they conduct their operations, their exposures to different borrower credits or industries, the nature of their trading activities, and other similar factors
A structured product issuer will typically be an issuer (and, often, a frequent issuer) of other securities. Accordingly, it will assess its Exchange Act reports and other disclosures to determine if they adequately discuss the potential impact (or uncertainties) arising from these developments. We anticipate that most issuers will update their incorporated documents, such as Forms 10-K and Forms 10-Q, with any needed changes, as opposed to making changes only to their structured product offering documents. Doing so will help ensure that these new Brexit related disclosures are incorporated by reference consistently across a wide range of offering documents.
Disclosures Relating to Specific Underlying Assets
The market gyrations following the announcement of the referendum results indicate that the values of a wide variety of investment assets may be affected by Brexit. Of course, the duration of these changes is not known at present and may change in the future. As a result, future levels of the underlying assets for various structured products have become even more unpredictable.
Equity indices tracking U.K. securities and European securities may be the most likely to bear the brunt of any adverse impact from these developments. Similarly, products that are “bullish” on currencies, such as the pound sterling and/or the euro, may also be adversely impacted. (Some analysts predict upswings in commodity prices, such as gold prices; however, experience may tell us to be careful about predicting future prices of any particular commodity. And of course, any initial increases may be followed by subsequent decreases.)
Market participants will want to review their disclosures as to different underlying assets, particularly the applicable risk factors, and the extent to which they reflect the uncertainties. That being said, the SEC rules (and market practice) do not mandate specific risk factor disclosure as to each and every macroeconomic market development, particularly where those developments are widely known, including by retail investors. Much as we lawyers may feel tempted to revise risk factors for any particular news event, some self-restraint may be appropriate.
A Brief Note About Suitability
Of course, a broker-dealer’s duties don’t end with good disclosures. Financial advisers will want to consider the extent to which recent changes in the financial markets impact what products should be recommended to which investors. In particular, for risk-adverse investors who are less willing to put principal at risk, a variety of products may warrant more careful review before being recommended. Our world has become just a bit more uncertain than it was before the referendum.