Afma’s retail structured product approval principles explained

Author: Ashley Lee | Published: 21 Mar 2013
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  • The Australia Financial Markets Association has compiled retail structured product approval principles to give comfort to retail investors wary of the products after the global financial crisis;
  • While most international principles focus on how financial advisors should advise retail investors, Afma’s focus on the issuer’s process in approving the issue of these structured products;
  • Other jurisdictions may look to the principles to establish international best practice related to the issue of retail structured products.

Retail structured products have been stigmatised following the global financial crisis. But the Australia Financial Markets Association's (Afma's) principles for retail structured financial product approval present an example for best practice across the Asia-Pacific.

Although the Australian Securities and Investments Commission (Asic) released both a regulatory guide and a report, it ultimately left the creation of principles related to retail structured financial product approval to Afma.

In comparison with Australia’s more muted reaction, some Asian jurisdictions cracked down on retail structured products after the global financial crisis. Hong Kong has been especially cautious following the complex recovery of collateral from Lehman Brothers mini-bonds.

Afma executive chairman David Lynch said that investor risk appetite for structured products has not been particularly strong since the global financial crisis, although a recovery in share market prices in the last few months may help build confidence.

He added that the principles should help the market to grow in this environment by helping to underpin the quality of structured products being offered to the investors.

Why the principles were created

Tracey Lyons, Afma’s director of market operations and retail, told IFLR that Asic suggested the product approval principles as a thought leadership piece.

She noted that Asic had done some work in terms of looking at the processes issuers were following when creating new products and how they were deciding how they would be distributed. However, she added that a lot of this work was done before the global financial crisis, when these products were more popular than at this point in time.

“Asic suggested that this would demonstrate some initiative within the industry to help in the process of restoring investor confidence,” she said.

King & Wood Mallesons’ Jim Boynton, who was on the Afma working group that developed the product approval principles, agreed that they are important to the future of the market. He said that although the regulators made a submission to a parliamentary enquiry, the government did not ban those instruments.

“Despite this, the regulator is watching what happens with these products,” he commented. “If there is a problem going forward, the regulator might want to revisit this issue.”

Australia-specific issues

Afma’s principles were largely guided by similar guidelines in Europe, such as the UK Financial Services Authority’s March 2012 Retail Product Development and Governance – Structured Product Review, and the Technical Committee of the International Organisation of Securities Commissions ‘s (Iosco's) Suitability requirements with respect to the Distribution of Complex Financial Products.

Other documents cited by Afma include those by the European Securitisation Forum, the International Capital Market Association (ICMA), International Swaps and Derivatives Association (Isda), the London Investment Banking Association and the Securities Industry and Financial Markets Association (Sifma).

But Afma’s principles also address some aspects specific to Australia’s retail structured product market.

Lyons noted that they focused on the process that an issuer would follow to develop these products, which differs from other international guidelines.

“We looked at the process that considered whether these products are appropriate to be distributed to retail customers as well as the critical issues that should be considered for the distribution mechanism,” she said.

Although most international guidelines - such as Iosco’s - focus on how intermediaries should classify and advise their customers, these product approval principles don’t address financial advisors.

Lyons explained that the principles do not address how an advisor should advise a retail customer about structured products because Australian law has quite specific requirements in this area. She added that Afma did not see a need to further clarify those obligations.

Instead Afma’s principles place a strong emphasis on internal controls, promoting a product approval policy that provides disclosure, manages risks and considers the suitability of target investors. Aside from legal and compliance risk, the principles address consideration of reputational risks and include a list of units that should be involved in product sign-off.

It also recommends that issuers address investor considerations regarding a product’s complexity, such as how to exit the product and how the product operates.

But the report also notes that this is not the issuer’s regulatory responsibility. Boynton said that in Europe, there are tests on whether a product is suitable or appropriate. In Australia, however, the statutory tests apply only where a financial advisor advises retail.

“There is no statutory obligation on the product issuer to ensure that the product is sold via appropriate distribution channels so that only informed investors buy these products,’ he said.

Regardless most significant institutions already have similar measures in place.

It was certainly apparent throughout the course of developing the principles that some entities meet these principles and in some cases go well beyond them, she said.

She added, “we’re quite confident that a number of Afma members have processes that go beyond these principles.”

Regional impact

It seems that the jurisdictions that tightened regulations on retail structured products are beginning to reopen.

Although only accredited investors can participate in the options market in Hong Kong, the Hong Kong Exchange (HKEx) announced its stock options market revamp on March 20. The initiative includes a Stock Options Corner on the HKEx website and a Facebook game with prizes such as iPods to encourage retail investors to learn more about stock options.

These principles may encourage industry associations and regulators elsewhere to establish similar regimes.

But Boynton was sceptical. He said that whether these product approval principles will be replicated elsewhere in APAC depends on what products can be offered in those countries and what restrictions are already in place.

Hong Kong has already implemented special rules for complex retail products so I doubt whether the principles will be taken up there, he added.

However Afma has begun looking internationally. Lyons said, “what we’re thinking about is how we can share the principles with colleagues in other jurisdictions.”

She said that the Asic chairman, who is the incoming chair of Iosco, has a particular interest in this area and has been talking about the product approval principles internationally, so we think that there’s a growing awareness of the work that’s been done in Australia.

“We hope the principles form part of the information that’s available to other countries that may be looking at these issues,” she commented.

Related links

APAC regulators to protect emerging markets from extraterritoriality

Why Australia’s proposed retail corporate bond boost won’t work

Q&A: Afma’s David Lynch