European regulator might issue warning on complex investment products

Out-Law News | 22 May 2014 | 3:07 pm | 2 min. read

The European Banking Authority (EBA) is considering issuing a warning to retail customers about the risks posed by investing in certain types of bank debt, such as contingent convertible bonds, according to the Financial Times.

The EBA is also considering asking the European Commission to grant it a mandate to act in relation to the sale of such complex financial products, the newspaper said. This might include banning the promotion of certain products to retail customers, requiring banks to disclose upfront the lack of deposit protection, and requiring individuals to sign declarations that they are aware such products are not covered by deposit guarantees.

Contingent convertible bonds, also known as coco bonds or coco notes, are a form of bank debt which can be converted to equity by a bank when a pre-specified threshold is reached. For example, if a bank's capital ratio falls below a certain desired level, the bank can "bail in" the cocos, to boost capital levels in an attempt to reassure shareholders.

In recent months a number of European banks have sold large amounts of debt which they could bail in as they attempt to strengthen their capital levels ahead of stress tests which the European Central Bank (ECB) will subject them to this summer, according to the Financial Times. Stress tests are hypothetical worst case scenarios, designed to establish whether a bank could survive a range of adverse economic events.

According to the Financial Times, analysts have said that cocos are not currently being sold to retail investors, but European regulators are nevertheless looking into the issue to avoid another mis-selling scandal in the European banking sector. The newspaper says that the EBA wants to ensure that banks do not target investors without making them aware of the risks associated with products.

The EBA is looking into the issue as part of its mandate to protect EU consumers in financial services," a spokesman for the EBA, which works to ensure effective and consistent prudential regulation and supervision across the European banking sector, told the Financial Times. "While it is too early to comment, we remain fully committed to identifying detriment consumers may experience in their dealings with banks."

One EU official told the Financial Times: “These are complex products and the risks are not very transparent. We think this [issue] is not going to go away.”

European regulators have been concerned about retail investment in bank debt since the Spanish bank Bankia was involved in a preference share mis-selling scandal, said the Financial Times. Bankia had to be rescued by the Madrid government in 2012. Its retail investors were forced to take losses on preference shares which they purchased without being aware of the risks involved, resulting in wave of legal action against the bank. Italy's Banca Popolare di Milano was subject to a class action by retail customers for an issue of convertible notes. The bank settled the action, making a provision of €47m, said the newspaper.

The board of the EBA, which convenes the banking supervisors of each of the EU's 28 member states, is expected to discuss measures to ensure depositors are better protected in the coming months, said the Financial Times.