Fears that Prospectus Directive update will curb structured product innovation

A change in the requirement for the final terms of a prospectus could restrict innovation in structured products, say market participants.

An amendment to the European Commission’s (EC) Prospectus Directive has meant that issuers of structured products are far more restricted on what they are permitted to include in their final terms, which some market participants say could result in them issuing simpler or fewer products to avoid the cost of producing additional prospectuses.

The stipulation is listed in Amending Directive 2010/73/EC, which came into effect on July 1 and relates to all member states across the European Economic Area (EEA). Issuers producing final terms to go with a programme for potential investors may only include information that relates to the securities note and the final terms cannot be used to supplement the base prospectus.

It means that if adjustments need to be made to the information provided about a specific product these can not simply be made in the final terms – the base prospectus would need to be rewritten. The amendment also states that the final terms must be prepared in an easily analysable and comprehensible format.

“It used to be the case with structured finance MTNs [medium-term notes] that tweaks were made to formulas – perhaps even new conditions added – and these were put in the final terms. Now that will not be possible, so the question is, what’s going to happen to those types of programme in the future?” says Andrew Roberts, partner in the debt capital markets practice at law firm Herbert Smith in London.

“Are we going to have more non-public, unlisted deals where there are only a few investors and exemptions from the Prospectus Directive are relied on so that these restrictions don’t apply? Or are we going to have increased standardisation and less flexibility because the cost of innovating on each product is going to increase?” says Roberts.

“I would ask whether these changes are going to be an impediment to innovation in the market,” he adds.

Julian Velarde, head of derivatives, corporate and investment banking legal at BNP Paribas in London, says he expects to see more standalone structured product issues using unitary prospectuses. These are standardised prospectuses that describe the underlying of the product and can incorporate, by reference, the base prospectus.

“Banks will probably go in two directions – the big issuers will try to get as much of their more vanilla products as possible into the base prospectus – all the formulas and risk factors – by defining all that upfront and including those details a year in advance.

“The problem is that in the case of more bespoke products issuers will attempt to do standalone and unitary prospectuses. This is problematic – there is more work involved and greater time required for their review.”

He adds that competent authorities will need to review the standalone prospectuses, but with this needing to be done within 10 working days of the submission of the draft proposal, some investment opportunities will inevitably be missed.

“It will potentially result in a reduced offering for investors and probably fewer participants in the market,” says Velarde. “It could have a dramatic impact on structured product issuance – the idea of trying to define everything upfront is quite a challenge for those who try and innovate,” he says.

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