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FSMA new guidelines on self placements by financial institutions

On 27 July 2015, the Belgian Financial Services and Markets Authority (FSMA) issued guidelines on self-placements (the Guidelines).

"Self placements" are placements of financial instruments issued by financial institutions in order to comply with capital requirements legislation, which are then sold to their own client base.The Guidelines refer to a Joint Committee of the European Supervisory Authorities (ESAs)10 communication reminding financial institutions of the regulatory requirements to protect investors, depositors and policy holders.11 An ESMA statement of the same date aims at clarifying to institutional investors the risks associated with investing in contingent convertible instruments (CoCos).

According to the ESAs, the complexity of the relevant financial instruments, the unusual nature of potential risks (in particular for retail clients) and the conflict of interests between the issuing institution and investors, may lead to mis-selling issues. These issues may also arise when self placements are distributed by insurance companies through unit-linked insurance products, especially when the issuer and distributing insurance company belong to the same group.

The Guidelines also contain recommendations on the provision of investment services in connection with self placements to retail clients whether via banking or insurance distribution channels.

Recommendations must be applied from 1 September 2015. The FSMA has said it will take the Guidelines into account when carrying out its supervisory activities.

Financial institutions covered by the Guidelines

The Guidelines do not expressly state the scope of application. However, the fact that (i) the Guidelines are presented as clarifications and additional recommendations with regard to the MiFID conduct of business rules and (ii) the FSMA will take them into account in its supervisory activities, indicates that they will apply to all providers of investment services to retail clients who are subject to the Belgian MiFID conduct of business rules.

Product scope of the Guidelines

The Guidelines cover three types of products:

  • (i) Contingent Convertible Instruments (CoCos).
  • (ii) Subordinated debt instruments that are part of the own funds of the issuer.
  • (iii) Financing instruments of credit institutions or investment firms, which may be triggered by a bail-in decision in the context of a resolution procedure.12

Product check via the product approval process

The FSMA considers that CoCos are, as a matter of principle, unsuitable for retail clients (MiFID definition) as it cannot be expected that those customers have sufficient knowledge and experience to understand the risks relating to these instruments.13 As part of the product approval process, manufacturers and service providers must take the necessary steps to ensure CoCos or instruments with significant exposure to CoCos are not sold to retail clients. Compliance officers must play a gate-keeper role in this context.

The investment services covered by the Guidelines are: the reception, transmission and execution of orders, investment advice and insurance intermediation services. Discretionary portfolios management is out of scope.

The FSMA acknowledges that a service provider may take the view that CoCos have a place in the investment portfolio of more wealthy retail clients, however, only for diversification purposes and for that part of the client portfolio under management exceeding EUR 500,000. In such cases, special attention must be paid to the duty of care requirements. One must check the knowledge and experience of the client in the light of CoCos. In addition, the investor must be warned that the FSMA considers that investments in CoCos are not suitable for retail clients.

The FSMA states that clients may only be qualified as "professional" clients with regard to CoCos if one carries out an adequate assessment of the knowledge and experience of the client in light of those instruments. Such assessment must provide a reasonable assurance that the client is capable of taking its own investment decisions and of understanding the risks related to CoCos.

Risk management

The Guidelines require that self-placing institutions pay special attention to the conflicts of interests related to the price-setting of these instruments. Conflicts of interests must be properly managed and appropriately disclosed to the client.14

In order to define a correct market conform price, the FSMA recommends relying on the price obtained via a book building mechanism in the professional market or, in the absence thereof, to build upon other internal or external professional and independent information and advice provided that it is thoroughly documented. Transaction prices on a liquid secondary market that are developed without the interference of the issuer may be used as an additional input. Financial institutions must develop a policy on this matter and document each decision in this respect in the product approval process.

The FSMA recommends that the marketing material clearly explains the credit risk deriving from the bail-in mechanism.

When offering the instruments covered by the Guidelines or when providing investment advice related to those instruments to retail clients, the FSMA recommends performing at least an appropriateness test with particular focus on the relevant product during the assessment of the knowledge and experience of the clients. The FSMA recommends doing so even when the test is not (yet) required by law, for example on the sale of a non-complex bond.15

For more details in relation to these developments please contact us.

Footnotes

10 JC 2014 62 of 31 July 2014.  
11 ESMA/2014/944 of 31 July 2014.
12 Article 43 of the BRRD.
13 CoCos come with features such as coupon skips, non-cumulative settlements, perpetual maturities with call features, principal loss absorption through equity conversion or security write-down, junior to subordinated debt conversion in a liquidations scenario.
14 Article 80 of the MiFID Royal Decree of 3 June 2007 and in Article 18 of the Royal Decree of 21 February 2014 on the conduct of business rules and the management of conflicts of interests in the insurance sector.
15 Appropriateness testing is legally required for the sale of complex financial instruments (under MiFID). The same applies for the sale of insurance products investing in subordinated debt instruments (Twin Peaks II legislation).

Legal and Regulatory Risk Note
Europe