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CoCos go pop!

05 August 2014. Published by Drew Naylor, Senior Associate

In the wake of the banking crisis, the Financial Services Act 2012 gave the FCA a range of new and enhanced powers with which to pursue its regulatory objectives.

Today, it has used – for the first time – one if its shiny new tools; the FCA has issued a Temporary Product Intervention Rule (TPIR).

A TPIR is a quasi-emergency restriction on the sale of a financial product(s) in the UK.  TPIRs are issued without consultation and can apply to some or all consumers, for a fixed period of time of up to twelve months.

From 1 October 2014, the FCA's first TPIR will prohibit the sale of contingent convertible securities (CoCos) to the "mass retail market" (i.e. unsophisticated consumers/investors) in the UK.  Sales have been restricted for the maximum period of time; the TPIR will be lifted on 1 October 2015.  The restrictions will not apply to professional, institutional and sophisticated/high net-worth investors.

CoCos are essentially loan notes and, in return for a capital investment, offer high interest rates.  However, if the capital position of the issuer falls beyond a stated level, the issuer may have the flexibility to write off the CoCo in full or in part or convert the CoCo into equity.  Of course, the flexibility to the issuer necessitates higher interest payments.

With the Bank of England's base rate likely to remain at its historic low for the immediate future, the FCA is concerned that 'ordinary' consumers will be tempted by the higher rates offered by CoCos, without fully understanding the risks associated with them.  Moreover, the market in CoCos is in its infancy and FCA is not sure how the products will be sold and/or operate in practice.  So, the FCA is deploying the precautionary principle and preventing any possible harm to retail consumers while (it would appear) it carries out a year-long investigation into the suitability of the product.

Haunted by memories of the recent past, the FCA is now delivering on its promise to adopt a 'safety-first' mentality when protecting retail consumers.  The age of the interventionist has been ushered in.  The FSA's 'light-touchers' have been shown the door.  Expect more TPIRs to follow.