UK regulator restricts sale of high risk securities to retail investors

The regulator limited the distribution of contingent convertible securities (CoCos) in October last year in the first use of its temporary product intervention powers, which allow it to act within consultation for a maximum of 12 months. Additional rules restricting the sale of certain mutual society shares will come into force on 1 July.

Financial regulation expert Michael Ruck of Pinsent Masons, the law firm behind Out-Law.com, said that the rules set out in the FCA's final policy statement were mostly identical to the draft rules it published for consultation in November.

"The key message for regulated firms is that the FCA is seeking to protect retail consumers from being mis-sold or exposed to high risk investments of this type," he said. "This follows on from the lessons it learnt in relation to 'death bonds', UCIS and other high-risk investments which have caused both detriment to retail consumers and to the wider reputation of the financial services industry."

"The FCA's continued stance in relation to investments of this type, following the first use of its product intervention powers in 2014, illustrates that the FCA will follow through on meeting its objectives and following up its use of interventionist powers. Firms should expect to see the FCA repeat its use of product intervention powers on an ongoing basis – in particular, one would expect to see these applied to protect retail customers," he said.

A CoCo is a type of hybrid capital security that can be converted to shares or written off entirely if the capital of the issuer, usually a bank, falls below a certain level. The FCA describes them as "highly complex instruments presenting investment risks that are exceptionally challenging to evaluate, model and price". For this reason, sales of CoCos to all retail investors, including sophisticated investors, will be restricted; limiting sales to professional and institutional investors.

The FCA has, however, loosened the rules slightly following feedback on its draft. The temporary rules apply to the sale, promotion or intermediation activities relating to CoCos; but the permanent rules will not apply to intermediation activities. This means that activities by firms higher up the distribution chain would not be affected once the final rules replace the temporary rules on 1 October.

Further rules which come into force on 1 July will limit the promotion and distribution of core capital deferred shares (CCDS) and similar shares issued by mutual societies. These instruments are similar in effect to CoCos and are also described by the FCA as "relatively unusual, complex and risky". It does not intend to completely restrict the sale of these instruments, in recognition of the fact that mutual societies do not have the same access to institutional markets to raise regulatory capital as the banks do. However, firms would be under a duty to ensure that investors have read certain risk warnings and are not committing more than 10% of their net assets to the investment.

The FCA initially proposed that the 'cap' on investment in this type of share would be limited to 5%. It said that it received "mixed" feedback in relation to its draft rules, with some arguing that these shares should be restricted in the same way as CoCos and others arguing that the cap should be raised. The new 10% cap included in the final rules is set at the same level as the cap applicable to direct offer promotions of securities to ordinary retail investors via crowdfunding platforms, the FCA said.

The regulator said that its new rules should "significantly limit the scope for consumer harm from inappropriate retail investment in these loss-absorbing instruments". However, financial regulation expert Michael Ruck said that it was not clear whether firms that had previously advised on the sale of CoCos to retail customers ahead of the FCA's actions should review that advice.