In August 2014, the UK Financial Conduct Authority (FCA) used its consumer protection powers for the first time and introduced temporary product intervention rules (Temporary Rules) that restricted the distribution of contingent convertible instruments (CoCos) and similar products to retail investors for a period of 12 months commencing October 1, 2014. These distribution restrictions did not impact the distribution of CoCos and similar products to professional or institutional clients, or to exempt persons.

In accordance with its stated intention when implementing the Temporary Rules, on October 29, 2014, the FCA published a consultation paper (Consultation Paper) in which it outlined proposed permanent rules on the distribution of CoCos and certain other core regulatory share capital instruments issued by mutual societies (together, Reg. Cap. Instruments) to retail investors. A summary of the Consultation Paper can be found here.

On June 16, the FCA published Policy Statement PS15/14 (Policy Statement) with respect to the distribution of CoCos and other Reg. Cap. Instruments in which the FCA summarized the feedback it had received from its earlier consultation, and also set out the final rules (Final Rules) that it will implement on the matter. Consistent with its earlier stated position in the Consultation Paper, and after having considered all feedback, in the Policy Statement, the FCA continues to regard CoCos and certain other Reg. Cap. Instruments issued by mutual societies as posing particular risks of inappropriate distribution to ordinary retail customers. Additionally, the FCA also remains of the view that the restrictions on retail distribution of CoCos and similar products currently in place under the Temporary Rules represent a “reasonable and proportionate regulatory response to the significant risk of harm to [retail] consumers that we have identified.” Nevertheless, based on feedback received, the FCA has made certain amendments to the Final Rules when compared with those proposed in the Consultation Paper.

With respect to CoCos, the scope of the Final Rules has been amended to only apply with respect to firms selling or promoting (or approving promotions of) CoCos (including CoCo funds) to retail investors (and which, therefore, do not apply to firms higher up the chain of distribution, such as those structuring products for distribution). The FCA does, however, reserve the right to further intervene if it finds that firms that are not subject to the Final Rules are acting in a manner that undermines the effect of the restrictions on the distribution of CoCos in the retail market. Unlike CoCos, for the reasons set out the Consultation Paper, the Final Rules continue not to restrict the distribution of Reg. Cap. Instruments to retail investors in their entirety, but instead impose certain requirements with respect to their retail distribution, including highlighting prescribed risk warnings and limiting the size of investment permitted to be made in this type of security by ordinary retail investors. Based on feedback received (and in contrast to the limit previously proposed in the Consultation Paper of 5 percent of net investable assets), the limit that the FCA is now applying in the Final Rules is 10 percent of a retail investor’s net investable assets (which more closely aligns with the approach taken by the FCA in other rules with respect to non-readily realizable securities where the limit also is 10 percent). These requirements continue to apply only to the primary market; however, the FCA intends to continue to monitor the situation and reserves the right at a later stage to extend the relevant provisions of the Final Rules to apply to the secondary market to the extent it considers necessary.

The Final Rules applicable to other Reg. Cap. Instruments issued by mutual societies take effect from July 1, whereas the Final Rules relating to CoCos take effect on October 1 upon the expiration of the Temporary Rules. A copy of the Policy Statement containing the Final Rules can be found here.