Earlier this year, the UK Financial Conduct Authority (FCA) used its new consumer protection powers for the first time when it introduced temporary product intervention rules (Temporary Rules) that restricted the distribution of contingent convertible instruments (CoCos) to retail investors. These Temporary Rules came into force on October 1 and last for a period of 12 months. As reported previously (see here), the Temporary Rules restrict all authorized persons from selling, promoting or intermediating transactions in CoCos (specifically those that are eligible as Additional Tier 1 or Tier 2 capital under Regulation (EU) No. 575/2013—the Capital Requirements Regulation), where such transactions result in ordinary retail investors owning the CoCos. The Temporary Rules do not impact the distribution of CoCos to professional or institutional clients or to exempt persons. 

In accordance with its stated intention when implementing the Temporary Rules, on October 29, the FCA published a consultation paper (Consultation Paper) in which it outlined proposed permanent rules with respect to restrictions on the retail distribution of CoCos (to replace the Temporary Rules upon their expiration on October 1, 2015), as well as requirements to be imposed when certain regulatory share capital instruments issued by mutual societies, including core capital deferred shares (RegCap. Instruments), are distributed in the retail markets. The Consultation Paper can be accessed here

The FCA makes it is clear in the Consultation Paper that it continues to view CoCos as highly complex instruments presenting investment risks that are exceptionally challenging to evaluate, model and price, and, which, as a consequence, are unsuitable investments for ordinary retail investors. The FCA has therefore proposed in the Consultation Paper to make permanent the approach taken in the Temporary Rules, so as to continue to restrict authorized firms from distributing CoCos in the retail market without first checking that the prospective client meets certain criteria concerning their net worth or investment sophistication. The FCA also has included proposals in the Consultation Paper that restrict the retail distribution of certain pooled investments that invest wholly or predominantly in CoCos. 

As with CoCos, the FCA also outlines in the Consultation Paper a number of concerns it has in relation to retail investment in RegCap. Instruments issued by mutual societies, which present investment risks similar in profile to those connected to CoCos. Nevertheless, while acknowledging those risks, the FCA also stresses its recognition that mutual societies may have little or no access to institutional markets to raise regulatory capital and (as a consequence of their structure and ownership), some consumers may genuinely wish to support mutual societies of which they are members by providing core capital. On this basis, unlike with respect to CoCos, the FCA has proposed in the Consultation Paper not to restrict distributions of RegCap. Instruments to ordinary retail investors in their entirety, but rather to impose certain requirements on their distribution, including highlighting specific risk warnings and limiting the size of investment permitted to be made in this type of security by ordinary retail investors, which the FCA has proposed be set at five percent of their net investable assets. The FCA also has proposed that these requirements apply only to the primary issuance and not to secondary market dealings in relevant securities. However, the FCA has stated that it may reconsider this position if it becomes apparent that firms are using secondary market sales as a way of getting around the requirements referred to above. 

Responses to the Consultation Paper are to be submitted to the FCA by January 29, 2015, following which the FCA will consider feedback and publish final rules in a policy statement prior to the expiration of the Temporary Rules in October 2015.