Fears that Prospectus Directive update will curb structured product innovation

An amendment to the European Commission's (EC) Prospectus Directive has meant that issuers of structured products are far more restricted on what they are permitted to include in their final terms, which some market participants say could result in them issuing simpler or fewer products to avoid the cost of producing additional prospectuses.

The stipulation is listed in Amending Directive 2010/73/EC, which came into effect on July 1 and relates to all member states across the European Economic Area (EEA). Issuers producing final terms to go with a programme for potential investors may only include information that relates to the securities note and the final terms cannot be used to supplement the base prospectus.

It means that if adjustments need to be made to the information provided about a specific product these can not simply be made in the final terms – the base prospectus would need to be rewritten. The amendment also states that the final terms must be prepared in an easily analysable and comprehensible format.

"It used to be the case with structured finance MTNs [medium-term notes] that tweaks were made to formulas – perhaps even new conditions added – and these were put in the final terms. Now that will not be possible, so the question is, what's going to happen to those types of programme in the future?" says Andrew Roberts, partner in the debt capital markets practice at law firm Herbert Smith in London.

"Are we going to have more non-public, unlisted deals where there are only a few investors and exemptions from the Prospectus Directive are relied on so that these restrictions don't apply? Or are we going to have increased standardisation and less flexibility because the cost of innovating on each product is going to increase?" says Roberts.

It could have a dramatic impact on structured product issuance – the idea of trying to define everything upfront is quite a challenge for those who try and innovate

"I would ask whether these changes are going to be an impediment to innovation in the market," he adds.

Julian Velarde, head of derivatives, corporate and investment banking legal at BNP Paribas in London, says he expects to see more standalone structured product issues using unitary prospectuses. These are standardised prospectuses that describe the underlying of the product and can incorporate, by reference, the base prospectus.

"Banks will probably go in two directions – the big issuers will try to get as much of their more vanilla products as possible into the base prospectus – all the formulas and risk factors – by defining all that upfront and including those details a year in advance.

"The problem is that in the case of more bespoke products issuers will attempt to do standalone and unitary prospectuses. This is problematic – there is more work involved and greater time required for their review."

He adds that competent authorities will need to review the standalone prospectuses, but with this needing to be done within 10 working days of the submission of the draft proposal, some investment opportunities will inevitably be missed.

"It will potentially result in a reduced offering for investors and probably fewer participants in the market," says Velarde. "It could have a dramatic impact on structured product issuance – the idea of trying to define everything upfront is quite a challenge for those who try and innovate," he says.

Another possible consequence of the amendment is that base prospectuses will need to have more optionality so that issuers can define all the various options upfront and avoid the expense and timing consequences of having to amend or supplement the base prospectus.

One concern about such increased optionality is that it will lead to base prospectuses becoming longer and more complicated and that the amount of information provided could end up baffling investors rather than making the investment process easier to understand.

A relatively important change within the Amending Directive is the requirement to have issue-specific summaries, which will run alongside the requirement to produce a key investor document (Kid) under the EC's Packaged Retail Investment Products (Prips) regulation, the final draft of which was released on July 3. "It's difficult to see why we would have to do both, which will be quite onerous," says Velarde.

"If the authorities are right about investors needing something short and sweet and not reading prospectuses why are we turning the industry upside down by requiring so much more detail to go in base prospectuses rather than final terms?" says Velarde.

Another amendment to the Prospectus Directive relates to an exemption whereby a prospectus is not required for offers made to a restricted circle of investors. The exemption now applies if the number of investors per member state, other than qualified investors, is fewer than 150, increased from 100.

Offers where the total consideration is at least €100,000 ($122,000) per investor for each offer are exempt from the prospectus provision, an increase from the previous figure of €50,000.

The required length of the summary document has been changed from a maximum of 2,500 words to either 7% of the total length of the prospectus or 15 pages, whichever is longer.

A grandfathering provision has also been added to the Prospectus Directive, meaning that final terms and summaries which have been approved by the relevant competent authority before July 1, 2012 can stay as they are until the beginning of July 2013.