ISDA Promotes MiFID for Harmonized Regulation of Complex Structured Securities

An ISDA led consortium told the European Commission the model provided by the Markets in Financial Instruments Directive (MiFID) is best adapted to the creation of a product-blind harmonized regulatory regime for complex structured securities products, The Commission is exploring the need for a harmonized legal framework regarding product transparency and distribution requirements for complex retail investment products. Other consortium members who signed on to the ISDA letter to the Commission were the European Securitization Forum he London Investment Banking Association, and the Securities Industry and Financial Markets Association.

ISDA emphasized that the basis of consumer protection in the securities market is the suitability obligation imposed under MiFID. The suitability of a particular product for a particular investor is a function of the investor’s knowledge and experience, financial situation and investment objectives. The complexity of a product is not a relevant characteristic in the making of this determination, said ISDA, what matters is whether the investor understands what the risks are and what the returns are likely to be.

MiFID adopts a service-based rather than a product-based approach to regulation, observed ISDA, and is considerably simpler than the approaches adopted in the other Commission Directives. To the extent that it makes sense to compare the relevant regimes, ISDA strongly believes that the MiFID approach is the best and most effective approach in terms of delivering effective consumer protection.

Securities products are offered to the public in the EU through distributors who are subject to the provisions of MiFID. In the view of ISDA, the key aspect of MiFID for this purpose is the suitability obligation, which is imposed on any financial intermediary executing an order on behalf of a retail customer. MiFID also permits an alternative, lower, standard of care, appropriateness, under which a retail customer positively declines to seek advice from the intermediary.

ISDA believes that the vast majority of complex securities products are sold by intermediaries who owe investors a suitability obligation. Securities may be sold to retail investors outside the scope of these protections, but this is only permissible for noncomplex products, continued ISDA, and derivatives and other retail structured securities will almost all fall within the definition of complex products in MiFID terms.

Because the securities markets are generally regulated on a distribution basis, noted ISDA, there is no limit on the complexity of the structures which can be created. But a false link is sometimes made between product complexity and product risk, continued ISDA, which leads to the illusion that complex securities are automatically high-risk securities. This is clearly not the case, in ISDA’s view.

In fact, ISDA pointed out that many structured products are structured specifically to provide investors with protection, that is, investors gives up some part of their potential return in order to increase the predictability of their final return. Products of this kind are optimized for investors with lower risk tolerances, and are likely to be unsuitable for investors who are actively seeking higher levels of risk.