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Ban on sale of “CoCos” to retail investors should be made permanent, says FCA

The ban on the sale of contingent convertible securities (CoCos) to ordinary retail investors should be made permanent, the Financial Conduct Authority (FCA) has said. The ban was the first use of the regulator’s temporary product intervention powers, 

Temporary FCA market interventions can last for a maximum of 12 months to give the regulator a chance to consult on more permanent restrictions. The proposed permanent rules set out in the FCA's new consultation, which runs until 29 January 2015, are broadly the same as the temporary rules, which came into effect on 1 October.

The permanent rules would also impose restrictions on funds that predominantly invest in CoCos. The FCA is also proposing new requirements that would apply when mutual society shares are sold to ordinary retail investors.

“One of our objectives is to ensure that consumers have the right degree of protection,” said Christopher Woolard, director of policy, risk and research at the FCA. “That is why the new rules we are proposing will make sure that there are appropriate safeguards in place so these complex instruments are offered only to investors who are able to make informed decisions about them.”

The FCA intends to publish final rules in summer 2015, ahead of them coming into force when the temporary CoCo rules expire on 1 October 2015.

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. According to the FCA, they are “highly complex instruments presenting investment risks that are exceptionally challenging to evaluate, model and price”. For this reason, the FCA is proposing to restrict their sale to all retail investors, including sophisticated investors; but not to professional or institutional investors.

The regulator is also proposing to limit the sale of the new types of shares that building societies are now able to issue in order to strengthen their capital levels to ordinary investors. While it does not intend to ban their sale entirely, firms would be under a duty to ensure that investors have read certain risk warnings and are not committing more than 5% of their net assets to the investment.

According to the FCA, these shares carry particular risks that could prevent an investor from selling when they want to, or affect the selling price, such as lack of liquidity. In addition, issuing firms do not guarantee the products, meaning that if the firm gets into financial difficulty the shares could lose value. The new regulations would only apply to sales made to retail investors that have not been certified as sophisticated or high net worth, and would not apply retrospectively.

The FCA said that although the market for the products covered by the consultation was “still fairly new”, it was likely to grow in the near future as banks and building societies attempted to built their capital reserves to meet new EU prudential requirements.

“We regard CoCos and common equity tier 1 (CET1) share instruments issued by mutual societies as posing particular risks of inappropriate distribution to ordinary retail customers,” it said in its consultation paper.

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