"People are struggling with the categorizations of complex and non-complex instruments," says Anders Malm, a partner with Stockholm-based law firm Oreum, which provides legal advice and services to structured note issuers.
Mifid attempts to simplify the product market into two basic types: complex and non-complex. Products that fall into the former category can only be sold on an advisory basis, with the advice provided by a qualified professional adviser. "Mifid says you may not sell complex products on an execution-only basis. If you want to sell a complex product then you have to give advice of one form or another, and of course that takes time and money," says Simon Gleeson, a partner at the Clifford Chance law firm in London.
Products regarded as complex lead to a much greater regulatory burden for the seller because products can only be offered using "appropriateness and suitability" tests, which puts the onus on the company that is in direct contact with the retail investor to establish whether the customer should be investing. The investment firm has to obtain information about the customer’s knowledge and experience of the specific type of product, their financial situation and investment objectives. Ultimately, the product seller has to be able to prove that the product provided is suitable for that particular customer, and this has to be documented for each client in case of subsequent review.
Complexity equated with risk
Mifid places any derivatives-based investment, regardless of how risk-averse its pay-off profile is, into this complex category. This is proving controversial. For example, take one of the most common structured products bought by retail investors, a note that provides principal protection plus exposure to the upside of an equity index. This is structured as a zero-coupon bond plus a call option, placing it automatically in the complex category, even though the underlying investment gives a relatively risk-averse exposure. A non-structured investment in stocks, on the other hand, falls into the non-complex category.
Critics say an investment in company shares is more complex from a risk perspective than a principal-protected note linked to the equity market. An investor in, say, a five-year principal-protected product at least knows that when the note matures he or she will get the initial investment back. Straight stockholders get no such guarantee, so arguably the risks underpinning an investment in a listed company, where there is no downside protection, is more complex than on a principal-protected note. Gleeson says Mifid fails to make a distinction between risk and complexity.
Oreum’s Malm says the issue caused a lot of consternation before Mifid was implemented, and is causing even more concern now that the regulation has kicked in. "Some of the local players up here are simply saying that they are engaged in primary market activities, and as a result the regulations do not apply. I don’t know how they come to that conclusion but they are trying to present this argument and leave it up to the regulator to tell them that they’re wrong," he says.