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Illiquid financial instruments

Consob in communication number 9019104 of March 2 2009 has set forth rules to be followed by intermediaries when offering illiquid financial instruments to retail investors. Illiquid financial instruments are not only bank bonds, insurance policies and over-the-counter derivatives, but may also include plain vanilla instruments to the extent that there may be difficulties to obtain a prompt liquidation.

Pursuant to the communication, intermediaries have to behave with fairness and transparency when they offer illiquid financial instruments to retail investors. In particular, prior to entering into investment transactions concerning illiquid financial instruments, intermediaries have to disclose to retail investors: (i) the characteristics, (ii) the fair value (calculated by marking to market) and (iii) the costs (spread) of the illiquid financial instruments offered; furthermore, they have to communicate to retail investors the procedures and the estimated timing required to liquidate the financial instruments offered, specifying the relevant risks related to the markets of trading.

It would also be advisable for intermediaries to compare the illiquid financial instruments offered to retail investors with other less risky financial instruments. The rationale of this provision is that retail investors should be in a position to evaluate both risks and returns of the illiquid financial instruments to be purchased.

Once the investment transaction in an illiquid financial instrument has been executed, intermediaries have to provide their retail investors with specific information (in particular costs and fair value) on the illiquid financial instruments held. When the illiquid financial instruments are directly issued by intermediaries, they (i) have to calculate the fair value on the basis of clear and common criteria and (ii) need to set in advance the mark-up value applicable through corporate procedures.

Intermediaries have to evaluate the adequacy and the convenience for investors of investment transactions relating to illiquid financial instruments. They have to take into account the characteristics of illiquid financial instruments and consider the level of financial knowledge and experience of the investors, verifying their capacity to understand the true risks associated to the specific investment transactions.

When intermediaries offer consultancy services, they have to evaluate the adequacy of illiquid financial instruments offered, considering the characteristics of both the investors and the financial instruments (including their costs and risks). In this regard intermediaries need to obtain from investors information relating to their (i) financial experience, (ii) investment targets and (iii) financial conditions. Finally, when intermediaries enter into investment transactions relating to over-the-counter derivatives for hedging, they have to inform the investors if the investment corresponds to their original hedging purposes.

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