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City watchdog to probe banks’ ‘novel, complex and untested’ products

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The Financial Conduct Authority (FCA) is planning a consultation on new complex financial products created by banks and building societies to boost their capital.

In a paper out today the FCA has banned the sale and marketing of high-risk, esoteric unregulated collective investment schemes (UCIS) to ordinary retail investors.

Elsewhere in the paper, the regulator said it plans a further consultation into some products being created by banks and building societies to boost their capital to meet the new prudential requirements.

The amounts banks and building societies are looking to raise suggest that these firms may consider offering these “novel, complex and untested financial instruments”, not only to institutional investors, but also to ordinary retail investors, the FCA said.

These products include contingent convertibles (CoCos), building society deferred shares and similar instruments that carry risks the FCA said will be unfamiliar to and inappropriate for many ordinary retail investors.

“We are concerned that these instruments could be promoted to retail consumers who do not have the necessary experience and understanding to evaluate them and who later face unexpected harm as a result,” the FCA said.

The FCA is worried a consumer could end up unknowingly buying a security for more than a professional investor would pay for it, and that there could be poor liquidity when the consumer tries to sell it on, particularly if the issuer should become prudentially stressed.

“We consider that the risks to ordinary retail investors are of sufficient magnitude to warrant consideration of a new marketing restriction for these products, to steer promotion to customers for whom the products are most likely to be appropriate, e.g. sophisticated or high net worth retail investors as well as professional investors,” the FCA said.

The regulator said it is a planning to consult on a new marketing restriction on these prodcuts “in due course”.

In the meantime, it is working with issuers to ensure these instruments are distributed in a way that stops ordinary retail investors from buying them.

One option the FCA is considering is to introduce an interim marketing restriction through a temporary product intervention rule to address the risks to consumers while it works on consulting on and introducing permanent rules.

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