Restrictions on Retail Distribution

Last year the FCA added a new chapter to COBS – COBS 22 “Restrictions on distribution of contingent convertible instruments”.  The effect of this was to prohibit the sale of, or allow the purchase of, a contingent convertible instrument (‘CoCo’) by a retail investor, subject to a limited number of exemptions. The rules in chapter 22 are temporary and currently cease to have effect on 1 October 2015. However the FCA had further thoughts on the matter and issued a Consultation Paper (CP14/23) with a view to making the restriction permanent – see Regulatory Roundup 60 for further details.

Policy Statement PS15/14 (“Restrictions on the retail distribution of regulatory capital instruments”) containing final rules has now been published. The rules come into effect in two tranches.

On 1 July 2015 a new section will be added to COBS 22 (22.2) relating to the retail distribution (dealing in or arranging a deal) of mutual society shares. There will not a restriction on such activities as such but rather specific risk warnings have to be given to the retail client, and the firm will be required to obtain confirmation in writing from the client that they have read the risk warning “in good time”. Note that this requirement will not apply to the trading of such shares in the secondary market. Exemptions are available for retail clients that are certified high net worth or certified/self-certified sophisticated investors in accordance with COBS 22.2.4, with COBS 22.2.6 concerning the required record keeping.  There is a further declaration to be signed by the client confirming that they are not investing more than 10% of their net assets in such an investment, although this only applies for non-MiFID business and where the client is not receiving advice.

The second tranche of rules comes into effect on 1 October 2015. As expected, the restriction on CoCos will continue to apply without time limitation by way of COBS 22.3. The restriction is now extended to include CoCo funds.  The prohibition means that a firm cannot sell such an investment to, or communicate or approve a promotion of these investments, where a retail client is involved.  Exemptions are set out in COBS 22.3.2.  Changes to COBS 9 (Suitability) will also be made.

COBS 9.3.5, which currently concerns non-mainstream pooled investments (‘NMPIs’), will be amended to reference not only the retail restrictions on NMPIs but to also reference the restrictions on CoCos (and CoCo funds), mutual society shares and direct offer financial promotions of non-readily realisable securities.

Although the new rules are not particularly complex, given the FCA’s general concerns on dealing in or promoting to retail clients what are perceived as higher risk investments, firms involved in business relating to CoCos and mutual society shares should gain a full understanding of the changes and consider what changes may be needed to internal processes and procedures.