In November 2016, Morrison & Foerster LLP sponsored Risk magazine's annual structured products legal and regulatory conference in Washington, D.C. Securities, tax, and ERISA practitioners at the firm participated in most of the panel discussions. For a summary of the key messages at the conference, presented by regulators, in-house counsel, product structurers, and attorneys in private practice, please see the following summary in Risk: www.risk.net/2477376. In this article, we will summarize a few additional subjects raised at the conference. International Regulators: How They Learn About the Structured Products Market U.S. and Canadian regulators discussed the means that they use to follow developments in the rapidly changing structured products market. In addition to attending seminars such as the Washington conference, these regulators:
- Share information with one another about interesting structures and new prospectuses;
- Obtain information from outside consultants, including individuals who may have previously held senior positions in the structured products industry
- ; and Review media coverage, including both industry publications and newspapers and magazines with broader circulation and broader industry coverage.
A panel covering know your distributor (KYD) and other relationships between underwriters, dealers and downstream dealers started off with a discussion about balancing the need for KYD with avoiding unnecessary intrusiveness during diligence. In its 2013 report on conflicts of interest, FINRA provided recommendations for dealers conducting diligence on the practices of their potential business partners in a distribution. The panelists discussed concerns about a dealer avoiding taking a "big brother" approach in this type of relationship. Another area of concern was that, where a dealer may be the issuer's hedge counterparty for a transaction, KYD procedures should ensure proper separation between trading and sales functions, so that the dealer's sales desk is not given an incentive to sell notes in order to generate hedging profits for the dealer. One panelist explained how technology tools such as a daily "scrape" of news articles, FINRA's Brokercheck and other sources on both the FINRA members and their associated persons, can be used as part of the KYD process as to particular dealers.
In the area of conflicts of interest, the panelists discussed proper disclosure of any preferred sales relationship between dealers in an offering, particularly if a dealer is receiving any kind of special incentive to participate in the offering. The disclosure can become more complicated if a dealer plays multiple roles, such as also being a calculation agent for the security or serving as the sponsor of a proprietary index. The panelists talked about concerns raised when a distributor requests that a "custom" risk factor be added to an issuer's disclosure document for a particular offering, particularly where such a risk factor may be immaterial or apparently not legally required under the circumstances. Issuers must balance this type of request against the potential for creating bad optics if one distribution channel has a particular risk factor and another distribution channel for the same product does not.
Recurring and potentially troublesome aspects of dealer agreements were then discussed. The panelists discussed how underwriters and dealers are addressing concerns about potential liability resulting from non-U.S. sales and methods to limit that liability. The solutions discussed included limiting a dealer's non-U.S. sales to an agreed upon list of jurisdictions, and using a dealer with expertise in particular non-U.S. jurisdictions. Dealer demands for diligence items such as opinions, comfort letters and officers' certificates were discussed next, along with how issuers and their affiliated underwriters respond to those requests. The panelists discussed the circumstances under which these requests are raised and potential solutions to address dealer concerns.
The conference's final panel consisted of front-office representatives of Bank of America Merrill Lynch, BNP Paribas and HSBC. The panelists discussed how the significant legal and business events of the past year impacted the nature of the products that were issued and the volume of offering activity: the DOL's release of its final rules, changes in the interest rate environment, and the U.K.'s Brexit vote. The table on the following page compares, on a monthly basis, 2016 issuances of registered structured notes compared to 2015 issuances. Panelists noted that aggregate issuances may be lower than they were through the month of the Brexit vote, but have recovered well on a month-to-month basis since the vote.
Average issuance sizes have decreased a bit by bit, year over year, although the 2015 average size was increased somewhat due to a number of extremely large issuances towards the beginning of 2015. Issuances are trending towards an increased portion of index-linked products, as opposed to individual common stocks. Panelists emphasized the industry's continuing commitment to creating products that can provide significant and tailored benefits to investors seeking to manage different types of market risks. Product innovation will continue, with a view to achieving these goals.
Click here to view the table.