British regulators have ruled that the new contingent capital securities (CoCos) that banks have recently begun issuing are just too complex for retail investors, and that they shouldn’t be able to buy them.
The UK’s Financial Conduct Authority (FCA) announced that it has determined that the new securities — which are being issued by banks as part of their response to new capital rules, and efforts by governments to prevent future taxpayer bailouts — are so complex that they are unlikely to be appropriate for retail investors. As a result, it is invoking its first use of new consumer protection powers to prevent the distribution of the instruments to retail investors starting in October.
The FCA says that the restriction with the distribution of CoCos to professional, institutional, and sophisticated or high net worth retail investors temporarily, while it undertakes a consultation on permanent rules in this area.
“CoCos can be written off (in part or entirely) or converted into equity when the issuer’s capital position falls, while issuers can have unusually broad discretion in relation to coupon payments making it extremely difficult for investors to assess, understand and price CoCos. At present there is little experience of how CoCos operate in practice,” it notes. And, while the market for these instruments is just getting started, the FCA says that it expects to see more firms issue CoCos in the future.
Last week, the European Securities and Markets Authority (ESMA) issued a statement on CoCos advising investors to be sure to assess all of the risks inherent in these novel securities, and warning that the necessary analysis is likely only possible by sophisticated, professional investors. Earlier this year, a group representing Canadian bond investors complained to policymakers that they weren’t given enough time to analyze the first-ever issue of CoCos subordinated debt issued by Royal Bank.
“In a low interest rate environment many investors might be tempted by CoCos offering high headline returns,” said Christopher Woolard, FCA director of policy, risk and research. “However, they are complex and can be highly risky, and the FCA has used its new powers to ensure that CoCos are not inappropriately made available to the mass retail market while still allowing access for experienced investors.”