Taiwan FSC backs down on structured products rules

The FSC's backtrack was met with a sense of relief both by foreign investment banks and local trust banks. These financial institutions had argued the rule might have shut down the structured product market in the country. This market has been almost dormant since the collapse of Lehman Brothers in September last year, which resulted in many retail investors losing money from capital guaranteed structures.

The FSC proposal was first divulged at an industry hearing on June 18, when the supervisor sought foreign and local bankers' views about a set of draft guidelines it intended to introduce to tighten the sales practices used by banks selling retail structured products to Taiwanese investors.

The rationale behind the 70% rule was to make Taiwanese trust bank distributors become the guarantors of structured notes sold to them by foreign banks. In the event of a foreign counterparty's collapse, Taiwanese retail investors could still retrieve some 70% of their initial investment, say bankers that attended the FSC meeting in mid-June.

"The 70% [cash tie up] is the biggest annoyance from our point of view; our business model is not run that way," said a Hong Kong-based banker who specialises in the Taiwanese structured product market. "If we needed to put proceeds with the trust banks we'd then need to take the credit risk of that bank, and we'll make a substantial haircut (on the interest rate we're paying on the note) for the credit risk we're running."

One of the most popular types of structured products in Taiwan is structured notes - fixed income securities linked to derivatives spanning asset classes including equities, interest rates, foreign exchange, commodities and credit.

Apart from requiring foreign banks to place the equivalent of 70% of the issued outstanding amount with a local trust bank - which could take the form of a bank deposit along with government and other bonds -the draft proposals also included a requirement that individual investors prove they had more than NT$50 million ($1.5 million) in financial assets before they could invest in structured produts. But this provision has also been retracted due to opposition from the local trust banks, bankers told Asia Risk.

"We think NT$50 million is too high for us - we have reflected our views since April this year," said a structured product marketing executive at a Taipei commercial bank. "In the past for retail individual investors, if you have $10,000 in financial assets then you can buy structured notes - that's the denomination set in the term sheets. So the NT$50 million proposed threshold was very unfavourable to the industry."

But he added the market for structured notes stopped several weeks before the collapse of Lehman Brothers last September, with few transactions having been done since July 2008. The collapse of Lehman Brothers, however, resulted in large losses for retail investors from credit-linked notes such as the so-called 'minibonds' issued by the US dealer both in Taiwan and other Asian markets such as Hong Kong and Singapore. This prompted supervisors in these markets to review their regulations governing the sale of complex derivatives sold to retail clients.

In the case of Taiwan, however, the FSC has appeared to be pushing out a slew of hastily conceived and quickly amended proposals to the industry. But the regulatory watchdog plans to stick with other proposed new rules, such as one that requires a foreign issuing bank to set up a local branch as a pre-requisite for continuing with its structured product business in the country. The FSC has not said when it would come up with the final draft of the guidelines.

A total of NT$2.66 trillion in notional value was invested in offshore securities during the first quarter of the year, of which NT$684.3 billion was in structured notes.

A full feature describing the new landscape for the structured products business in Taiwan will appear in the forthcoming July edition of Asia Risk.