The FSA's tough task

In the first of a series of interviews with national regulators, we talk to the UK's Financial Services Authority about the taskforce it is setting up with other European regulators to assess the size and value of the losses suffered due to the failure of Lehman Brothers. Richard Jory put the questions to the asset management sector team, headed by Dan Waters, the FSA's director for retail policy and conduct risk, and 'sector leader' for asset management

Structured Products: Which government departments are responsible for the regulation of retail and institutional structured products in the UK? Explain the legislative responsibilities for the governance of retail and or institutional structured products.

UK Financial Services Authority: Under both European Union and UK legislation, the FSA is responsible for the regulation of UK-based firms that provide investment products or services. As far as structured retail products are concerned, we have several responsibilities, including the regulation of firms that provide financial advice, which may be to buy such products, and the assessment of the capital adequacy of firms that may provide the debt instruments that underpin structured products. We do not regulate retail structured products as a separate class. Structured products may take many different forms, each of which will have different regulatory implications under our regime. In fact, structured products are not 'regulated' products as such, unless they are constituted as authorised unit trusts, Open Ended Investment Companies (Oeics) or recognised schemes.

In addition, in the UK, structured or market-linked term deposits are considered distinct from other structured products because they are 'deposits' as defined in article 5 of the Regulated Activities Order. With deposits, the initial capital is deposited with an authorised deposit-taking firm (bank, building society or credit union) on terms under which it will be repaid.

SP: What has been the effect of the collapse of Lehman Brothers on the governance of structured products, and how have you responded to this?

FSA: We are reviewing the impact on UK investors of the failure and insolvency of Lehman Brothers and its European subsidiaries. For UK retail investors, a significant impact has been the complete or partial failure of capital protection of a number of structured products where that capital protection wholly or partially comprised debt assets issued by Lehman's European or offshore subsidiaries.

In the aftermath of Lehman's failure, the FSA has worked with its European colleagues on a taskforce to consider particular issues that have arisen from its insolvency. One key aspect of the work of this taskforce has been to assess the size and value of the retail structured product population which was affected by Lehmans' failure. In addition to this assessment, the taskforce has also come up with a number of recommendations for existing Europe-wide workstreams, such as to consider how structured products are distributed and sold to retail customers across Europe.

We are in the process of considering the issues highlighted by the failure of Lehman, and the implications these have for our regulatory regime as it applies more widely to structured retail products. For example, we have been considering the quality of marketing material and risk disclosures in communications issued for the products affected.

SP: Where has your intervention - either by adjudication or legislation - been most required in the field of structured products?

FSA: We intervene on a proportionate and risk-based basis. For example, we have previously taken action in respect of structured capital-at-risk products (Scarps) and the details are available on the FSA website.

In summary, to address risks relating to Scarps, we:

- issued repeated alerts to consumers about the risks associated with Scarps;

- issued guidance to firms requiring their financial promotions to explain clearly the risks to consumers, and to be clear, fair and not misleading;

- made policy changes requiring firms to provide appropriate and 'balanced' information; and

- took supervisory and enforcement action against firms that had produced promotional material which was not clear, fair and not misleading, or which had sold Scarps inappropriately.

SP: What regulations on structured products had you introduced before the bankruptcy of Lehman Brothers?

FSA: As a result of our implementation of the European Union's Markets in Financial Instruments Directive (Mifid), we did not include product-specific rules relating to structured products in the Conduct of Business sourcebook (Cobs), as they are not regulated as a 'class' of products. However, services relating to the sale, provision, maintenance and marketing of structured products are subject to detailed rules in Cobs.

SP: What regulation do you plan to impose, or have you imposed as a result of the bankruptcy of Lehman Brothers?

FSA: We are in the process of considering the issues highlighted by the failure of Lehman Brothers, and the implications these have for our regulatory regime as it applies more widely to structured retail products.

SP: What is your usual consultation process for the implementation of new regulations on structured products?

FSA: Under the terms of the Financial Services and Markets Act (FSMA) - the statute that lays out the role and responsibilities of the FSA - we are required to carry out cost-benefit analysis and market failure analysis, and to consult stakeholders in advance of making any rules.

SP: In what ways have you dealt with the mis-selling cases that structured products tend to throw up?

FSA: Any investor that feels he or she has been sold a product that was not suitable for their needs is entitled to complain to their adviser. Investors who are not satisfied with their adviser's response may then submit their complaint to the Financial Ombudsman Service.

SP: How many people in your organisation work in structured products and in which specific departments are they located?

FSA: We are not a regulator of 'structured products' as such, but of regulated activities and promotions relating to them. A number of supervisors may be allocated to firms which advise on, sell or manufacture investment products, including structured products. These products will also be considered in the course of our policymaking and implementation of European Directives.

SP: Are there any other areas of the government that have responsibility or influence over the regulation of structured products?

FSA: Various government departments are likely to have an interest in structured products, including the Office of Fair Trading.

SP: Are structured products suitable investments for the retail investor market?

FSA: We are unable to make any comment on or assessment of the generic suitability of types of products for retail investors. That is not part of our statutory role under the FSMA. However, we do consider and enforce relevant disclosure and advice requirements arising from the Prospectus Directive and the Mifid, both of which have been fully implemented in our regulatory regime. For example, marketing documentation provided to investors about such products must be clear, fair and not misleading.

SP: What mechanisms have you adopted to ensure you hear the views of investors, product providers and distributors of structured products?

FSA: We supervise all UK firms that provide investment products or advice on investment products, including banks. We collect information on the sales of certain investment products and we carry out regular assessments of the quality of advice provided by samples of intermediaries across a range of their customers.

SP: Are you aware of the retail structured products principles as defined by the five trade associations led by the Joint Action Committee?

FSA: Yes.

SP: How have you implemented Mifid? What difficulties have this piece of European legislation presented and how have these been overcome?

FSA: We have fully implemented this Directive.

SP: Are the rules governing structured products the same as for other retail investments?

FSA: It depends. The rules governing structured products, and other retail products, vary depending on a number of factors such as the nature of the firm, the product, the target market and sales process. In addition, firms are subject to our high-level principles, which include the requirement that firms must treat their customers fairly.

SP: What are the main differences between the rules you have for retail structured products and those for other investment products, such as mutual funds and insurance products?

FSA: Structured products are not regulated as a class of products. How our regulatory regime applies to the products themselves is largely a function of what products are structured as - a regulated CIS, an unregulated CIS, an investment bond, a deposit, and so forth. The only regulated investment products in the UK are those constituted as authorised collective investment schemes.