Mayer Brown: regulatory focus, a reflection of the market growth

As the US retail structured products market continues to grow regulators have turned their attention to complex products and disclosures.

The Financial Industry Regulatory Authority (Finra) has added a reminder about registered indexedlinked annuities (Rilas) to the variable annuity section of its examination and risk monitoring priorities for 2023 report - the regulator is asking financial firms to be ready to show examiners their disclosure practices at the point of sale and wants to know if the products’ disclosures address buffer and cap rates, as well as market value adjustment risks.

The Finra updates comes as the bill to streamline regulatory paperwork for index-linked annuities approved by the US Senate is now waiting a vote in the House of Congress which has already raised questions about the moves from Finra and the SEC to introduce new rules covering the retail sale of complex investment products.

“There has certainly been a lot of focus by regulators in the last year on complex products as a reflection of the market growth,” said Anna Pinedo (pictured), partner, Mayer Brown.

Pinedo notes that Finra’s focus on complex products sold to retail investors is on disclosure and appropriateness whereas the SEC has a few areas of particular focus, including additional guidance on Regulation Best Interest (Reg BI) from the SEC Office of Examinations relating to conflicts of interest and the types of relationships that broker dealers and investment advisors have in the context of products that they recommend.

“This is a very important area for our clients in the structured products market because it is a market where many parties are related and participate in the sales as well as the product structuring and product manufacturing process,” she said. “As a result, the SEC concern around potential conflicts of interest with third parties arising in the context of Reg BI is understandable.”

RILAS

According to Pinedo, the recent update from Finra on Rilas does not signal a renewed scrutiny on one of the fastest growing product types over the last two years as the “focus is not so much on Rilas but rather on annuities generally”.

The Finra report discusses annuity sales to retail investors and flags a couple of areas of concern relating to the sale of Rilas.

“This is not new but instead a reminder of Finra’s focus on products sold to retail and it is a continuing area of focus under an old Finra rule - Finra rule 2330, which has been around for a very long time,” said Pinedo.

The reason for including this in the report is the recent market interest we have seen in annuity products which are very retail oriented.”

FINRA wants to make certain that member firms offering Rilas have the right disclosure processes and the appropriate policies and procedures to review their sales process and the training they provide to their registered representatives when making a recommendation, according to Pinedo.

“The focus on product structures and disclosures around ‘buffers’, ‘caps’ and ‘floors’ relates in part to appropriateness and is also the result of the increased interest we have seen in annuity products lately and coincides with an increase in product sales,” she said.

“Finra wants to ensure the right disclosures are in place when making recommendation on products that have different mechanisms and variables that can impact the final return.”

The Rila bill that was approved by the US Senate is now awaiting a vote in the House of Congress, however Pinedo believes “it's very unclear whether that will pass” and that there is “no certainty that the legislation will get adopted”.

Hot Topics

Another hot item in the US regulatory agenda as a separate issue is the introduction of new rules aimed at indices as a whole following the launch last year of the consultation on matters related to the activities of certain information providers, including whether information providers are acting as investment advisers under the Investment Advisers Act of 1940.

The SEC is potentially considering whether index providers and other calculation agents, publishers and administrators of indices should be regulated in the United States.

“We'll see whether that request for comment turns into something this year,” said Pinedo, adding “the SEC has many other priorities in its agenda and has a very full plate in terms of regulation.

“I'm not sure that we're going to see anything on indices immediately,” she said.

Other topics on top of the US regulatory agenda for 2023 which will have an impact on the structured products market include ESG and the lingering Libor rate.

“I think that we will see final rules on climate change from the SEC in April or May, as well as new guidance that will apply to funds that use ESG in their name and claim that they invest in ESG assets,” said Pinedo.

“This could have an impact on structured products as many link their payoffs to the performance of ETFs or funds that have ESG investments embedded.”

According to Pinedo, the market has reached a point where there is a need for clarity about how people think about and use ESG in their investments.

“We also have seen some enforcement actions from the SEC against companies and funds that have allegedly misled investors with products that are ESG related. This will continue,” said Pinedo.

Libor will also remain on the agenda in 2023 although the discussion has moved towards CMS linked notes or notes tied to indices where Libor is a leg of the index.

“Libor is still relevant and part of the discussions with clients,” said Pinedo.