The business and regulatory environment for structured products continues to evolve, sometimes in ways that surprise all of us. In this final article, we identify a few items to look out for in 2013.
Estimated Value. Market participants will probably remember 2012 most for the SEC’s April 2012 sweep letter, and its focus on the disclosure of estimated values of structured notes. As of the end of 2012, most market participants have not revised their structured note offering documents, as they continue their discussions with the SEC staff, await additional guidance from the SEC, and/or complete their internal valuation procedures. If the SEC does in fact provide any additional guidance, and as issuers have the opportunity to consider best practices in connection with the new disclosures, we may see further evolution in these disclosures.
New FINRA Communications Rules. On February 4, 2013, FINRA’s new communication rules, 2210 and 2211, will become effective. Market participants will be furnishing a greater number of free writing prospectuses and similar documents relating to structured products to FINRA, and obtaining principal review for a variety of offering documents. Based on the new submissions, it is possible that the FINRA staff will reach out to specific broker-dealers, or to the market generally, as to any disclosure practices that it deems insufficient.
Amendments to Regulation M. The SEC has not yet issued final rules with respect to its proposal to remove the references to investment grade securities from Regulation M.11 Any revisions to Regulation M may impact the manner in which structured notes are offered, and the manner in which broker-dealers create a secondary market for them.
Conflicts of interest. The SEC issued proposed rules to implement the Dodd-Frank Act Section 621 prohibition on material conflicts of interest relating to certain securitizations some time ago, and has not finalized these rules. The conflicts of interest proposals may affect certain structured products that are issued in reliance on a special purpose vehicle or trust. The conflicts of interest rules are expected to be finalized toward the end of the first quarter of 2013, in conjunction with final action on the Volcker Rule.
Volcker Rule. The Volcker Rule also may have an effect on the structured products market, especially on the type of secondary market activity that will be permissible for underwriters of structured products. Based on recent statements by regulators, we anticipate that the Volcker Rule will be finalized by March 2013.
FINRA and Conflicts of Interest. In July 2012, FINRA commenced a street sweep, soliciting information as to how participants in the structured products market identified and managed conflicts of interest.12 Once FINRA has evaluated and digested the information obtained by the sweep, it may take additional actions, including the identification of best practices for industry participants, or sanctioning broker-dealers that have not made proper disclosures or maintained proper procedures.
Role of Third Party Distributors. Both the SEC and FINRA have taken an interest in the role that third-party dealers (i.e., distributors other than the lead underwriter, such as selling group members) play in the distribution of structured products. At times, questions have arisen as to how these distributors are selected and screened by the lead underwriter, and whether these distributors have adequate sophistication and training to offer structured products for their customers. The “know your dealer” regime remains largely unregulated in the U.S., with different market participants following different procedures, and making different decisions as to which entities they will permit to participate in their offerings. 2013 may see additional scrutiny, and perhaps additional guidance, as to the role that these distributors play.
Reverse Inquiry Transactions. Both the SEC and FINRA have raised questions to market participants relating to reverse inquiry transactions. This process in part reflects the process by which these regulators are becoming more educated as to the role of reverse inquiry transactions from registered investment advisors and other sophisticated investors in the offering process. Questions have arisen as to whether the existing disclosure and pricing practices, including the new estimated value disclosures, remain as relevant for these types of investors, and whether differences in the offering process and offering documents are appropriate in these cases.
Proprietary Indices and Related Guidance. Broker-dealers continue to seek to enhance their range of offerings, and to provide useful investment tools for investors, by developing a range of proprietary indices. Of course, due to potential uncertainties under existing legislation, including the Investment Company Act and the Investment Advisers Act, many issuers and underwriters have taken a cautious approach to some proposed products. Whether in 2013, or at some later point, market participants will hope to obtain more clarity as to the rules of the road, and the extent to which their affiliated broker’s investment recommendations and/or discretion can play a role in developing these indices. Efforts by industry organizations, such as the Global Financial Markets Association,13 to identify standards relating to new market measures may also gain traction as best practices in the market.
European Regulatory Developments
PRIPs Initiative Developments. Regulatory initiatives with respect to Packaged Retail Investment Products (or PRIPs) gained momentum this year, with the publication of draft regulations in July 2012 and first EU presidency compromise proposal on November 27, 2012. The regulations require that in circumstances where an investment product is sold to retail investors, a Key Investor Document (KID) must be prepared by the product ‘manufacturer’. It is expected that further consideration will be given by the European Parliament and the Counsel of the EU to the legislative proposals during 2013, with a vote by the European Parliament’s Economic and Monetary Affairs Committee scheduled for March 20, 2013. It is not expected, however, that the regulations will apply until mid-2015.
EMIR Reporting Requirements. Transaction reporting requirements in respect of derivatives transactions in the European Union will be phased in from 2013 onwards. Where there is a registered trade repository available, transaction reporting of credit and interest rate contracts will be required from July 1, 2013. This is the earliest possible date from which transaction reporting under the European Market Infrastructure Regulation (EMIR) shall be required. If there is no registered trade repository available on or before April 1, 2013, reporting must take place within 90 days after registration of such trade repository. If there is no registered trade repository available on or before July 1, 2015, reporting commences on July 1, 2015, directly to the European Securities and Markets Authority (ESMA). Transaction reporting in respect of all other types of derivatives contracts shall not be required until 2014 at the earliest.
UCITS V. In July 2012, the European Commission published a legislative proposal focusing on amendments with respect to the duties of depositories (safe-keeping, oversight and delegation), the remuneration of UCITS managers and the ways in which the relevant rules could be better harmonized. It is expected that the proposal will be further considered by the European Parliament during 2013, although it is also widely believed that member states will be given around 2 years to transpose the amendments to the existing directive into their national laws. Accordingly, it is unlikely that any changes will come into effect until the end of 2014 at the earliest.
MiFID II. Legislative proposals intended to replace and recast the Markets in Financial Instruments Directive are slated to be considered by the European Parliament in its plenary session on October 24 / 25, 2013. Such scheduling comes a full year after the proposals were originally intended to be considered.
Financial Conduct Authority (UK only). On April 1, 2013, the Financial Services Authority (FSA) will finally be replaced as the UK’s single financial services regulator. The Financial Conduct Authority (FCA) will assume its new role as regulator of wholesale, retail and financial markets, the infrastructure which supports those markets and as prudential regulator of firms which do not fall under the scope of the new Prudential Regulation Authority (PRA). These changes are likely to result in new powers of the FCA to utilize temporary product intervention rules. A consultation on these issues is currently underway and it is intended that a final statement of policy will be published in advance of the legal cutover to the FCA in April 2013.
Retail Distribution Review (UK only). Efforts have been made in the UK to ensure that there is greater clarity with respect to advice provided by investment advisers. Measures which come into force in 2013 include: (1) a requirement that firms state whether they offer “independent advice” (i.e., personal, unbiased recommendations based on a comprehensive and fair analysis of the relevant market) or “restricted advice” (i.e., where an advisor is tied to specific products), (2) stricter requirements regarding minimum qualification levels for advisers and in respect of their continuing professional development (CPD); and (3) a ban on traditional forms of commission (paid by product providers to investment advisers) in respect of advised sales relating to investment products. Instead, consumers will pay an agreed investment adviser charge, either in the form of a fee or as part of the product.