France forces full disclosure

Regulation Update

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France's structured products market is one of the most lucrative in Europe, having raised in excess of EUR12 billion last year alone, according to an official at the French financial regulator, Autorite des Marches Financiers (AMF). However, the increased "retailisation" of the structured products market has been causing concern about the ways in which products are distributed and commercialised, says Hubert Reynier, managing director and head of regulation and international affairs division at the AMF in Paris.

In an effort to protect retail investors from instances of so-called mis-buying, the AMF has requested that all product providers provide additional information pertaining to the product's risk levels in its advertising literature. "The AMF has taken this measure in order to ensure that advertising material adequately informs investors and that adequate procedures are set up in order to ensure the appropriateness between the risks attached to the instrument, the process of the marketing and the profile of the target investors," explains Veronique Cerneau, the AMF's senior officer of international affairs.

The new version of the General Principles applying to "advertisements relating to transactions involving the offer to the public of financial instruments which are indexed or which contain an option component," was instituted on December 27, 2005.

The new version is more broad-based in its reach and all product providers must comply with the requirements, Cerneau says. If they choose not to, they must explain their reasons for doing so through the principle of "complain or explain", she adds.

According to Cerneau, the measure does not effect the formation of a cross-border EU market for structured products. "As long as structured products comply with French law, any of them (structured products) can be offered (in France)," she insists. But the General Principles does leave issuers liable for an additional layer of compliance and legal costs, which is especially pertinent for foreign (cross-border) providers wanting to tap the French market but not subject such stringent requirements in their own country, explains Denis Cohen-Bengio, head of retail product management and development at Axa Investment Managers.

The Luxembourg regulator, Commission de Surveillance du Secteur Financier (CSSF), does not require providers to supply any marketing material for review, says Cohen-Bengio. But many Undertakings for the Collective Investment of Transferable Securities (Ucits) products, which can be passported across the EU, are domiciled in Luxembourg, so these products' entry into France is directly affected by the AMF's rules. "But if you are aware of the delays (caused by the additional French requirements), it's easy to overcome," Cohen-Bengio says.

French issuers are unphased by the rules because the strong appetite among French investors for more exotic and complex structures means many providers already subscribe to the AMF's requirements. "In a majority of cases, issuers' advertising materials already meet the General Principles requirements," Cerneau notes.

"We have been providing such disclosure for over a year now," notes Cohen-Bengio. "The AMF insists that our advertising material explains the cash lock-in risks, the level of leveraged exposure and the cost of the guarantee," he says.

Investor's interests

According to Reynier, who first voiced the AMF's concerns over the further retailisation of structured products during the Structured Products Europe 2005 Conference in November last year, the need for increased disclosure is a result of the growing sophistication of the products that are coming to market.

As structured products have become more popular, the AMF has noticed that products are becoming more complex and diverse in terms of underlyings and payoff structures, Reynier says.

Until now the AMF has resisted placing formal restrictions on the retail structured products market. "Structured products can be sold to anyone in France without any threshold, and when using alternative underlyings the only condition we insist on is that the minimum investment is EUR10,000 or there is capital protection," Reynier explains.

In light of this growing complexity, and in the absence of any formal restrictions on retail structured products in France, the AMF is taking precautions to ensure the safety of those investors who make decisions based on the advertising material rather than the product prospectus.

The new version of the General Principles stipulates that all structured products that are marketed to the public must include risk disclosure in all advertising literature even if the product has already been approved for distribution in other EU jurisdictions and adheres to the EU Prospectus Directive 2003/71/EC.

While considered as a separate requirement, the AMF's General Principles is eclipsed by the detailed and stringent nature of the French regulator's existing prospectus requirements. Even though the Prospectus Directive is aimed at harmonising the contents and format of the prospectus for the purposes of a single, passported prospectus across the EU, member states are free to impose their own eligibility requirements, Cohen-Bengio says.

And the AMF's prospectus requirements are more extensive than those imposed by some other regulators, he adds. "When we submit our prospectus to the CSSF, it consists of two pages, but the prospectus submitted to the AMF can reach as much as 30 or 40 pages," he says.

In order to be granted approval by the AMF, a prospectus should also include a summary, comprising a description of the product and its rules. Management objectives must be presented clearly and reiterated in the summary, while details of the product's formula or structure and its inherent risks must be clearly explained. A prospectus should also offer potential scenarios so the investor knows what to expect in the event the market behaves differntly to the scenarios outlined, Reynier notes.

Back-testing must also be carried out and guarantees should be cited. In the interest of liquidity, early redemption fees should be put in place. "Providers must take the right measures to explain the relevant circumstances of early redemption," Reynier says. And if a product is linked to an index rather than an asset class, the provider should explain what an index is and how it is defined as an investable asset class and the risk it incurs. "The integrity of the structured products market must be upheld," Reynier emphasises.

The AMF's extensive disclosure requirements for advertising material and prospectuses resemble those adopted by the Financial Services Authority (FSA) in the UK, which is known for its cautious approach to the retail distribution of structured products and alternative investments.

All advertising literature in the UK is fully subject to the FSA's oversight via the "financial promotional rules", while all prospectuses must meet the FSA's "conduct of business requirements", explains a London-based spokesman at the FSA.

A softer touch

While regulators in France and UK adopt a stricter approach to disclosure, making cross-border distribution cumbersome, regulators in countries such as Sweden and Finland are leaving it up to the industry to decide how they improve on transparency standards.

The Structured Products Association of Finland (Spaf), which formed in June 2005 and comprises Nordea, Handelsbanken, Sampo Bank, SEB Bank and OKO Bank, is planning to release a set of recommended terminology and common guidelines for product providers to use in their marketing material, according to Helsinki-based Janne Saarikko, head of global structured products at Nordea and chairman of Spaf. The Finnish regulator's approval is currently being sought for the new guidelines, but Saarikko envisages no objections.

In Sweden, product issuers have been quick to self-regulate after the regulator there threatened to introduce separate legislation for disclosure. The industry has responded very quickly to the regulator's warning, says Helena Pajander, global head of structured products at SEB Bank in Stockholm. Many providers have increased the level of transparency in their advertising material, she says.

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