Regulation: A troubled transition

Special report: Focus on Italy

Most structured products professionals welcomed the European Union's Prospectus Directive, which was implemented by all of the EU member states in July last year. The supposed benefits of the directive were clear enough: it was designed to standardise the information that issuers are required to disclose to investors by introducing a 'single passport' rule for issuing securities. In reality, though, regulatory problems have been compounded. Issuers contacted by Structured Products say they are unaware of any providers that have successfully launched a product in Italy using the directive.

The Italian market also saw the arrival of the savings law no. 262/2005 ("Provisions for the protection of savings and the regulation of financial markets") in May this year. The new regime is supposed to offer more protection to investors, but has been subject to several amendments following severe industry criticism. The proposed amendments will transfer some of the powers of the Bank of Italy to Italy's financial regulator, the Commissione Nazionale per le Societa e la Borsa (Consob), including responsibility for structured products regulation.

Consob is yet to publish rules clarifying the types of 'standard' products that can be offered without requiring its pre-approval. This has led to confusion among issuers, especially given that some structured products prospectuses have already been turned down or deferred by the regulator. The Bank of Italy was responsible for structured products, and had the power to reject offerings. Consob has been responsible for disclosure requirements but it's likely that they will take on Bank of Italy's role.

Taken together, the changes have damaged the market for structured notes. Some observers say that structured products issuance in Italy has ground to a halt since the savings law was implemented, with several issuers offering no new products at present.

One way to sidestep Italy's apparent regulatory minefield is to offer structured investments in fund format, and a few constant proportion portfolio insurance (CPPI)-based and option-based capital-guaranteed funds have been successfully approved for sale to the mass retail market.

The amendments are likely to make Consob the sole regulator of Italy's structured products market. Product providers contacted by Structured Products agree that the transition period is slowing down the whole structured products market in Italy. "Thanks to Article 129 it is easier to issue plain vanilla products under the Bank of Italy's jurisdiction," says Andrea Cecchini, head of marketing and sales at Credit Agricole Asset Management (CAAM) SGR in Milan. "Banks are now interpreting the rules themselves."

Under Article 129, the Bank of Italy can prohibit or postpone an offering within 20 days of receipt of notice. In October last year, it published a list of products and characteristics deemed acceptable for issues of less than EUR2 billion notional, and which therefore do not require Article 129 authorisation. Capital-guaranteed products are exempt, for instance. But the introduction of the savings law means the outlook for the types of offerings fit for retail investors is uncertain.

The aim of the savings law is to protect retail investors. "In the wake of Parmalat and Argentina, and the collapse of various other corporate bonds, questions regarding the protection of retail investors were raised by the Minister of the Economy," says Dario Loiacono, managing partner of law firm Loiacono E Associate in Milan. "The savings law addressed many of these issues, but it wasn't coordinated very well with the rest of the Italian and European legal framework. At the end of August this year, the government proposed several amendments to the savings law, which are currently being debated."

The legislation covers the majority of financial products, including structured products. The problem for issuers is that the decisive factor in securing approval is not the level of disclosure, but whether the product comes with a capital guarantee. In effect, issuers can distribute any type of product so long as they are guaranteed, but they will have to bear the entire risk of repaying the capital if anything goes wrong.

It was therefore no surprise that the savings law was subject to widespread criticism from market practitioners when it first came into force. Loiacono was among those who voiced their concern. "There are two main reasons why I am against a paternalistic approach. First, it obstructs financial innovation, which in the long-term hinders the sophistication of our intermediaries. Second, by assuring a sort of protection ex-post rather than ex-ante of the investor, it doesn't force the investor to think carefully about what he is buying and therefore impedes the sophistication of the investing public," he says. "It unnecessarily transfers the risk of insolvency of the issuer from the investor to the intermediary, thus indirectly increasing the financing cost for the issuer."

As a result of criticism from the industry, the government proposed several amendments, the most significant of which was a recommendation to change the Bank of Italy's role.

Transfer of powers

The proposed regime will remove the power of the Bank of Italy to deny approval of structured products using Article 129. Consob, meanwhile, has not formally confirmed its new role or said whether it will, like the bank, publish a list of standard offerings that will receive automatic approval. Unsurprisingly, issuers contacted by Structured Products are baffled by the current situation.

Some banks are unsure about what to do at present. "We don't know whether the transition of power will be smooth or not," says Vito Elia, co-head of fixed income and equity derivatives marketing for Italy at Credit Suisse in Milan. "But the number of applications for issuance of structured products has fallen since May."

Observers have also noted that Consob's inexperience in structured products is delaying the approval process on the marketing materials. Consob has already taken on one of the Bank of Italy's responsibilities in authorising marketing literature, including products prospectus. "There is a lot of confusion and inefficiency on all sides, not just Consob," says Maurizio Morini, head of exotic products structuring and trading in Banca Akros in Milan. "Loading the investor with pages and pages of disclaimers does not improve their understanding of structured products."

Most market participants are unsure whether Consob will publish anything similar to the requirements set out by the Bank of Italy. "Consob should publish clear guidelines that include a list of products and underlyings for structured products issuers," says a Milan-based executive director of a major structured products issuer. "The transition hasn't helped the business. We hope clearer guidelines from Consob can bring more innovation to the structured products in Italy."

Most issuers believe Italy has a lot of untapped potential, and that dealing with just one regulator will increase efficiency. Roberto Bartolomei, vice-president, equity derivatives sales at Nomura in London, is optimistic about the future prospects for issuing structured notes in Italy under Consob. "It's good news for the issuers because the transition will remove uncertainties in the long term," he says.

The amendments to the savings law are soon to be debated in the Italian Parliament. The Prospectus Directive is likely to be more effective once the domestic legislation on investor protection is clarified, which may encourage foreign issuers to passport their offerings into Italy. Market participants anticipate that Consob will take a more active role in regulating the structured products market when the details of the savings law are finalised.

The good news is that the amendments are likely to be passed, according to a source close to the Italian regulatory community. As a result, the Bank of Italy will retain the power to ask questions only about types and size offerings. But the purpose of this is to monitor the stability of the financial system rather than to protect the investors.

At present, providers have to deal with the regulatory hurdles if they wish to issue structured products in note format or wrap their offerings as fixed-income securities. However, it has been proved that it is relatively easier to offer investments as funds.

Structured funds

Italy's fund market is one of the biggest in Europe. In the first quarter of this year, net sales of foreign-domiciled funds amounted to EUR21.1 billion, according to a study by the European Fund and Asset Management Association (Efama). In total, Italian investors contributed EUR7.9 billion into undertakings for collective investments in transferable securities (Ucits) in the first quarter of this year.

These funds are mostly open-ended, so close-ended structured funds are something of a novelty. To tap the fund market, CAAM SGR, a savings management company created by the partnership between Credit Agricole and Banca Intesa, launched the CAAM Guaranteed Formula 2012 last month. The formula fund, or structured fund, is the first in Italy, according to CAAM SGR's Cecchini.

The six-year capital-guaranteed fund pays 100% of the average of the positive performances of a basket of three equity indexes: the DJ Eurostoxx 50, the S&P 500 and the Nikkei 225.

CAAM Guaranteed Formula 2012 is targeted at fund investors. CAAM's own research shows that two-thirds of investors in funds prefer risk-free or low-risk products. Capital-guaranteed funds are relatively new to the market, and because capital is repaid on maturity, they have struck a chord with the local investors.

Guaranteed Formula 2012 is aimed at the mass retail market and is distributed by the institutions of the Italian Bank Division of the Intesa group: Cariparma, BiverBanca, Banca di Trento e Bolzano, Banca Popolare FriulAdria, Intesa Casse del Centro (CR Viterbo, CR Foligno, CR Rieti, CR Spoleto, CR Citta di Castello, CR Terni e Narni, CR Ascoli and CR Fano).

CAAM SGR has already had some success with another CPPI-based, five-year guaranteed fund, Intesa Garanzia Attiva I semestre 2006, which was launched at the end of last year. "Our formula funds and CPPI funds are the first of a kind because they provide capital guarantees," Cecchini says. "The formula funds were fully subscribed after 15 days of launch. We would like to launch these products on a regular basis."

Observers say the capital-guaranteed fund market in Italy will dominate as a result of the changes in regulation. "CPPI products are flooding the market. Consob seems to be comfortable with them and they are being processed quickly," Morini at Banco Akros says. "They are the first products to hit the market under the new regime."

But there are even more regulatory changes ahead. Market participants are awaiting the implementation of the Markets in Financial Instruments Directive (MiFID) next year, designed to create a single market in financial services in the EU, which may shed a little more light on Italy's problematic financial market.

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