It's been called the biggest threat to the structured products market you've never heard of. The first part of that assertion might turn out to be an exaggeration, but the second part is, for most folk, certainly true.
The UK's Consumer Rights Act 2015 (CRA) – a piece of legislation that updates the UK's compliance with a decades-old European Union directive – is meant to weed out unfair practices in the sale of household appliances, but it has issuers and lawyers fretting that the same rules could be applied to structured products.
The Act provides a so-called 'grey list' of terms that could be construed as giving an unfair advantage to the seller. Unfortunately for certain structured notes, the terms are used widely in documentation.
Early redemption clauses, for example – a prerequisite of issuer-callable products – could be in the firing line. Particularly vulnerable are terms where the issuer has the right to call a product on demand for an issue unrelated to market dynamics – to comply with an unexpected tax bill, for instance – and where the amount returned to the investor is net of deductions they have no insight into, such as hedge unwind costs.
In the worst-case scenario, contracts that contain such terms could be rendered unenforceable in a court of law, rendering them null and void. Or the UK Financial Conduct Authority (FCA) could ban their sale altogether.
Several of the market's largest issuers – including Credit Suisse – tell Risk.net that the Act has already upended the way they look at structured products documentation
Already, the industry has begun to mobilise its resources, combing through contracts to rid them of terms that could fall foul of the CRA. Several of the market's largest issuers – including Credit Suisse – tell Risk.net that the Act has already upended the way they look at structured products documentation.
In its 2015/16 business priorities plan, the FCA guidance to firms under its jurisdiction cited the CRA as bringing the issue of unfair contract terms into sharper focus, suggesting the watchdog may already have had suspect clauses in its crosshairs.
UK-based law firm Ashurst has put together a presentation for the industry listing the five big dangers posed by unfair contract terms: legal risk that terms would be branded unenforceable in court; reputational risk arising from potential FCA investigations or having to give public undertakings; product intervention risk that certain products would be banned or amended by the regulator; prudential risk from product costs being different to those thought to be relevant when the product was first launched; and governance risk, where management is put in the firing line for failing to spot vulnerable terms.
All of this might feel like a bad joke to issuers that have spent the past several years seeking to comply with a welter of EU and national-level regulation, much of it aimed at tightening up point-of-sale disclosure practices.
But perhaps therein lies the problem: as the industry awaits the latest regulatory technical standards to accompany the Packaged Retail and Insurance-based Investment Products (Priips) regulation, the resources consumed by compliance, legal and regulatory staff – and, as the rules come closer to go-live, those in the front office – leave the industry vulnerable to unexpected threats.
Ironically, the Priips regime, with its relentless focus on transparency and simplicity of information, should put an end to any notion of unfairness when it comes to required disclosures – and with it the whiff of opacity that lingers unfairly around structured products.