Structured products liquidity under threat from EU reforms

Incoming reforms of the European structured products market could drain liquidity from thousands of outstanding retail investments, industry participants fear.

The European Union's new regime for packaged retail and insurance-based investment products (Priips) – which takes effect from January 1, 2017 – requires issuers to produce detailed key information documents (KIDs), including cost, risk, and performance scenarios, for all products made available for sale to retail customers.

In a written response to enquiries from the Joint Associations Committee on Retail Structured Products (JAC), the European Commission last month confirmed there would be no grandfathering provisions in the final Priips regulation – meaning all products issued prior to the implementation date will be captured by the KID requirement if they have a viable secondary market. This could incentivise issuers to shut down secondary markets in outstanding products as a way to duck the KID mandate.

"You could have the rule of unintended consequences here, because if the entire population of existing products are caught, manufacturers are going to have to produce KIDs for everything. That is not a small number, a small expense, [or] a small operational challenge. The only way you fix that, if you can't be compliant with the KID requirement, is to pull liquidity," said Tim Hailes, chair of the JAC, speaking at a Risk.net event on May 5.

An outstanding Priip without a secondary market would not be considered as available for sale, Hailes reasoned, and therefore would not be required to have an accompanying KID.

There is no political appetite to delay the implementation of Priips and KIDs
Tim Hailes, Joint Associations Committee on Retail Structured Products

Penny Miller, a partner in the financial services regulation practice at law firm Simmons & Simmons in London, says the commission's letter was "helpful", as it clears up the issue of whether the Priips mandate would capture privately placed structured notes sold to high-net-worth individuals through a private bank where there is no secondary liquidity.

David Stuff, chief executive of Cube Investing in London, argues the absence of grandfathering provisions will hit issuers in continental Europe – where mature markets such as Germany and Switzerland feature a large number of listed products – particularly hard.

"If you are a large European bank that has been issuing listed products, you've had an issuance programme in place for years where you list thousands of products on exchanges. The issuance cost has been microscopic, and in order to meet investor demand you've offered huge swaths of products - even for those where there may be no open interest. Now, all of a sudden Priips is telling you there are going to be large maintenance costs for those products. I can imagine a huge delisting programme as a result," he says.

Zak de Mariveles, London-based chairman of the UK Structured Products Association, says the total volume of structured products circulating in Europe stands at 1.25 million, making the KID mandate "a major issue" for manufacturers.

"Such volumes require a fully automated technical solution, something that eludes us all due to the large number of outstanding questions and issues related to the implementation of the Priips regulation. Without this clarity, the likelihood of having enough time to code, test and implement diminishes as each day goes by. Arguably we are already past the point of no return, which is one key reason for the industry's strong push for a delay to the regulation," he says.

On April 27, four European trade associations, including the European Structured Investment Products Association, sent a letter to the EC urging a one-year delay to the implementation of the Priips regime, citing the "considerable operational challenges" that manufacturers would need to overcome to be compliant by the end of this year.

However, speaking on May 5, the JAC's Hailes counselled against relying on regulatory forbearance. "There is no political appetite to delay the implementation of Priips and KIDs. We can keep asking, but that is my reading of where we are today," he said.