The Bundesanstalt für Finanzdienstleistungsaufsicht (Bafin) has conditionally rescinded a ban on the sale of credit-linked notes to retail investors that it announced on July 28, subject to the successful implementation of 10 principles for the issuance and distribution of credit-linked notes. The principles were presented to Bafin by the German Banking Industry Committee (Deutsche Kreditwirtschaft) and certificates association (Deutsche Derivate Verband (DDV)) and published earlier today.
"Bafin will continue to monitor the market for CLNs, examine matters as part of its ongoing supervision and, where necessary, intervene," said a Bafin official. "The method of verification will also depend on future market developments. For example, it may be possible to undertake analyses like those which were carried out in the thematic work on CLNs (information about issuing, distribution activities, advisory documentation)."
Issuers and distributors have until the end of the year to introduce the new measures, although Germany's financial regulator has reserved the right to review the effectiveness of the new protocol. 'In the next six months, we will be monitoring very closely whether self-regulation will adequately protect retail investors investing in creditworthiness-related debt securities,' said Elisabeth Roegele, executive director at Bafin, in a statement.
In view of the industry's comprehensive self-commitment, the purpose of the planned ban - to significantly improve investor protection - can be achieved in a comparable manner, according to the Bafin official. For example, "Complexity: The main risks will be better explained both by issuers and in the course of distribution," said the official. "This includes the complex definition of 'credit event'. Particularly complex product variants (worst-of, first-to-default) will no longer be issued. Products will only be issued with a fixed rate and no longer with a floating rate.
"Distribution among retail clients: The minimum denomination per unit and the decision not to sell to the two lowest risk tolerance categories will serve to protect risk-averse retail investors," said the official. "Other principles of the self-commitment lead overall to a reduction in the risks of CLNs (only reference entities with investment grade and listing on organised markets)."
The self-regulation proposal includes an alteration to the name of the product - from the "misleading" Bonitätsanleihe (creditworthiness note) to bonitätsabhängigen Schuldverschreibungen (credit-linked debt security) from January 1, 2017. "The discussion included only one name for the product, and reflects Bafin's criticism," said Christian Vollmuth (pictured), a managing director at the DDV. "There was no name competition."
The English designation remains "credit-linked notes", and, on a point of clarification, the Bafin official confirmed that step-up coupon CLNs are normally not issued with a variable coupon.
Bafin decided to rescind the ban on the basis of the "the overall package, such as the uniform/standardised proceeding of producers and distribution," said Vollmuth. "The principles address many points of the Bafin's criticism. We have already shown with the Fairness Code that we can implement such voluntary commitments effectively and in the interest of the investor."
According to the principles, credit-linked notes will only be issued at a minimum investment size of €10,000, which takes them out of being "typical" retail investment products. '
Stringent requirements are also laid down with respect to product distribution, according to the principles. For example, CLNs with more than one underlying company can only be offered if investors achieve actual risk diversification. 'In addition, retail investors are to be provided with more extensive information when investment advice is provided for this product,' stated the DDV.
Assurances and education for retail investors are enshrined in principles 5 and 10: "Clients are provided with product information that comprehensibly describes the product structure and clearly indicates the risks, especially the contingency of interest payments and repayments on the non-occurrence of a credit event (together with an explanation of said credit event), as well as a concrete description of the consequences for the retail client of the occurrence of a credit event," said the Bafin official.
"For the purpose of investor protection, as a first step in the distribution of credit-linked notes, particular consideration is given to the knowledge and experience of the investor with respect to the product structure of credit-linked notes," said the official. "As a second step, investors are provided with additional product-specific information. In particular, investors are informed of which credit events relating to the reference entity can lead to (partial) non-payment of interest or nominal value. The risks are particularly highlighted in the documentation."
Verbraucherzentrale Bundesverband, Germany's consumer protection association has yet to respond to the regulator's announcement, but "will for sure comment on this tomorrow or on Monday in the German media," said Vollmuth. "It is expected that the association will complain, as it explicitly welcomed the ban. But much more interesting will be the reaction of the Deutsche Schutzvereinigung für Wertpapierbesitz [Germany's oldest and largest association for private investors]."
The degree to which the certificates market as a whole will change due to the self-commitment remains to be seen. "However, in relation to CLNs, the self-commitment will bring about greater transparency and make the issuing of products more consumer-friendly," said the Bafin official.
With the CLN ban on hold and strong indications that it will be removed, Bafin is turning its attention to CFDs (contracts for difference) and binary options.
The release from Bafin is available at the following link:
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