PD3 will have a significant impact on structured product industry

23 August 2017 Consultancy.uk

While many will still recall the pain of “PD2” implementation in 2012, the European Union (EU) has announced a new Prospectus Regulation that will repeal and replace the existing Directive, becoming fully effective in 2019. Despite taking the form of a Regulation rather than a Directive, this new Regulation is commonly being referred to as ‘PD3’. Sarah Natt from Delta Capita discusses what the PD3 changes mean, and why there has never been a more pressing time to act in the Consultation process. 

What do the changes mean?

Without a doubt, the changes introduced in the new Regulation will mean a significant amount of thought, discussion and work for structured product issuers and their advisors, so that they ensure their issuance prospectuses and programs are compliant with the new requirements. While some of the changes appear to help issuers, others may be of limited use unless accompanied by other industry developments.

Some of the changes will present significant challenges. The approach to risk disclosure in the prospectus is a classic case in point. The Regulation prescribes that risk factors will be presented across a limited number of categories and be set out in order of materiality, based on their probability of occurrence and the expected magnitude of their impact.

The chapters of risk factors found in the average structured products program typically cover a broad spectrum of events. Insolvency and bail-in, regulatory/taxation changes and market disruption events are just a few examples. These events then need to be ordered in accordance with their materiality, which is likely to involve prolonged debate and difficult decisions. 

It is, of course, possible that the materiality may change dependent on the type of product, the circumstances of the issuer or investor, and the latest regulatory developments. This “ranking” approach is certainly novel within the capital markets industry. Issuers may look to their legal counsel for advice, but will law firms be able to give meaningful guidance or opinions?

PD3 will have a significant impact on structured product issuers and their advisors

The requirement to produce an Issue Specific Summary will remain, although issuers will no longer be required to include a summary in their base prospectus. This makes some sense, but issuers will still need to maintain a live template to enable them to produce the Issue Specific Summary quickly and accurately. 

A new limit also has been placed on the length of the Summary, which could be cut by at least half its current length. As we have seen with the recent PRIIPs KID requirements, limiting the length of issuance documentation presents many challenges in itself. Although the Regulation permits certain required information regarding the securities to be fulfilled by the content of the PRIIPs KID, much more detailed guidance is certainly needed – particularly when it comes to the interaction between these two documents and their prescribed formats, as those still grappling with the overlap and inconsistencies between MiFID II and PRIIPs will be all too familiar with. During the massive PRIIPs implementation projects, issuers may simply not have considered that the KID would eventually be used to replace some of their prospectus content. 

The approach to risk factors in the Issue Specific Summary for a product is even more restrictive, as it includes an arbitrary limit of 15 risks that can be contained in the Summary. This is likely to cause a further headache, as issuers attempt to determine their “top” 15 risks. 

Another significant change within the new Regulation is the ability to take into account whether the securities have a denomination of “at least €100,000 or are to be traded only on a regulated market … to which only qualified investors can have access” when determining the information that is material to an investor. This clarification to the disclosure standard is potentially useful for more complex products sold to a single sophisticated investor, but unless such securities have a high denomination, the requirement is not as helpful as it first appears. This is because there are very few regulated market segments that are restricted to qualified investors. With this in mind, only time will tell whether the exchanges will develop new markets to enable issuers to take full advantage of this change.

Time to Act

The new Prospectus Regulation will clearly bring about some significant and difficult changes. However, despite the current overload of regulatory implementation work within the structured products industry, issuers should not overlook the need to consider these changes to the prospectus regime now. Issuers should be prepared to engage in the debate about how to assess the materiality of risk factors, to ensure the regulators are informed about the challenge this presents and are steered toward giving some form of practical criteria. They did act upon some of the concerns raised by the industry during the PRIIPs consultations, proving that there is willingness to listen to a united industry voice. It is essential that the Level 2 measures and technical standards provide clear and helpful guidance to issuers seeking to update their issuance programs – “PD3” is here and there has never been a more pressing time to act in the Consultation process.

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