Temporary product intervention rules

Restrictions in relation to the retail
distribution of contingent convertible
instruments


Introduction

1.
Contingent convertible instruments (commonly known as CoCos) are hybrid capital
securities that absorb losses when the capital of the issuer falls below a certain level.
They are risky and highly complex instruments that, in the coming years, are likely to be
issued in large amounts by financial institutions such as banks and building societies as a
result of new prudential requirements being implemented in response to the financial
crisis.

2.
We regard CoCos as posing particular risks of inappropriate distribution to ordinary retail
customers (i.e. retail clients who are neither sophisticated nor high net worth or who do
not meet any of the other permitted criteria set out in the rules shown in Annex 2).
Given the pressures to maintain a prudent capital position and the current low interest
rate environment, there is a significant risk that these loss-absorbing instruments will be
inappropriately promoted to retail investors searching for yield and income.

3.
The European Supervisory Authorities (ESAs) have recently issued two communications
to firms and investors of the risks of these instruments.1

4.
The Financial Conduct Authority (FCA) has now made temporary product intervention
rules, which will come into effect on 1 October 2014 and lapse on 1 October 2015. These
rules impose restrictions in relation to the distribution of CoCos to retail investors.

5.
This communication explains the scope of the temporary rules and exemptions available,
as well as providing the FCA’s rationale for making temporary rules. It also explains how
these temporary rules interact with our upcoming consultation on permanent rules for
CoCos.

1 http://www.esma.europa.eu/content/Placement-financial-instruments-depositors-retail-investors-and-policy-holders-
Self-placemen and http://www.esma.europa.eu/content/Potential-Risks-Associated-Investing-Contingent-Convertible-
Instruments

Scope of the temporary rules

6.
The temporary rules apply to all authorised persons in the UK, including both issuers of
CoCos and firms promoting or intermediating transactions in CoCos. The rules have no
effect in relation to the distribution of CoCos to professional or institutional clients, or to
exempt persons. The rules do not restrict the distribution of prospectuses issued in
compliance with the Prospectus Directive, and do not apply to clearing, registration,
settlement, custodial or back office processing services.

7.
For the purposes of the temporary rules, investment in CoCos does not include indirect
exposure via investment funds or occupational pension schemes. The rules apply even if
there is no client relationship between the firm and the retail investor (as may be the
case in relation to sales by the issuer, for example).

8.
In relation to retail investors, the rules generally do not permit firms to sell, promote or
intermediate transactions in CoCos that would result in ordinary retail investors investing
in CoCos. However, to the extent a firm’s activities amount to MiFID or equivalent third
country business, the rules only apply restrictions in relation to promotional activities and
not to the sale or intermediation of the transaction in CoCos.

9.
Firms engaging in MiFID or equivalent third country business are reminded that
compliance with the restrictions on promotion introduced by the temporary rules does
not exhaust their regulatory responsibilities. Their duties under the client’s best interest
rule (COBS 2.1.1R) as well as the suitability (COBS 9) and appropriateness (COBS 10)
rules are particularly relevant in the context of intermediation of transactions in CoCos
for retail clients.

10.
Whether or not the activities amount to MiFID or equivalent third country business, a
number of exemptions are provided in relation to the restrictions in the temporary rules.
Subject to conditions, firms may sell, promote or intermediate transactions in CoCos (as
the case may be) if the retail investor is certified as a high net worth investor,
sophisticated investor, or self-certified sophisticated investor, or if the consumer has
specifically requested advice without receiving previous communications from the firm
about investment in CoCos.

11.
The rules also require firms to make a record of their assessment of the retail investor
under the available exemptions where they promote (or approve financial promotions of)
investment in CoCos. These records must be made by the firm’s compliance function,
and the person allocated the compliance oversight function at the firm must review the
certification process at least every 12 months.

12.
Where firms make a promotion to a sophisticated or high net worth individual, we expect
the firm to give the client a written copy of the relevant statement signed by the
individual.

13.
Firms are reminded of our existing rules and guidance in COBS 2.4 on treating agents as
clients and on reliance on information provided by other persons. A firm is generally able
to treat as a client another firm acting as agent for an end-client. The firm can rely on
information about the end-client given to it by that firm. Even where the intermediary
firm is not acting as agent for an end-client, in determining whether they comply with the
temporary rules, a firm may generally rely on information provided in writing by another
person, if it can show it was reasonable to do so.

The FCA’s rationale for intervention

14.
CoCos are highly complex, hybrid capital instruments with loss-absorbency features
written into their contractual terms. One key characteristic is that they feature an equity
conversion or writing down trigger, set with reference to the issuer’s capital position in
relation to regulatory requirements. CoCos eligible towards issuers’ Additional Tier 1
(AT1) capital also feature other unusual characteristics for non-equity instruments, in
that they are permanent notes with entirely discretionary income payments. This means
‘coupons’ may be cancelled at any time, for any reason, and the notes may never be
called. While CoCos can be designed in a range of different ways, all are highly complex
instruments presenting investment risks that are exceptionally challenging to evaluate
and model.

15.
CoCos help inhibit risk transfer from investors to taxpayers. That is, in times of financial
stress for the issuer, it is intended that investors should bear the costs of recapitalisation
without the need for public funds. This is an important role but highlights a particular
concern from a conduct perspective: CoCos are not designed to meet an identified need
of target market investors. Their design is largely dictated by requirements for regulatory
capital. Many of their characteristics are highly unusual and largely untested, which
means the risk/benefit ratio may operate in ways even sophisticated investors do not
expect. Features that relate to the issuer’s ongoing capital position may be opaque in
their operation and risks. Furthermore, risks to investors that flow from the possibility of
the issuer’s exercise of discretion are extremely difficult to evaluate.

16.
Overall, these are securities that are inappropriate for distribution to ordinary retail
investors. Despite significant market appetite for these instruments, there is growing
concern that even professional investors may struggle to evaluate and price CoCos
properly. This suggests that firms selling, promoting or intermediating transactions for
sophisticated or high net worth retail clients should be particularly careful to safeguard
the interests of those consumers.

17.
The FCA has been developing a considered approach to the conduct risks posed by the
distribution of CoCos. We have been working closely with UK issuers over the last 16
months to ensure the new securities are marketed in a way that minimises the risk of
inappropriate investment by ordinary retail investors. This has largely been achieved
through voluntary agreement by issuers of high minimum denomination values.

18.
We first outlined our concerns about CoCos in Policy Statement 13/3 in June 2013.2 In
that statement, we noted that we planned to consult on a new marketing restriction and
that we would work with issuers in the meantime. We also noted that ‘one option is to
introduce an interim marketing restriction through a temporary product intervention rule
to address the risks to consumers while we work on consulting on and introducing
permanent rules’.

19.
With an increasing number of new issues of CoCos expected in the coming months and
years, we believe the supervisory approach explained above is no longer appropriate or
an efficient use of FCA resources. We are also concerned that it may not offer sufficient
protection to consumers, for example in relation to inappropriate distribution of CoCos
issued overseas. While we are now in the final stages of developing our approach for the
consultation exercise in relation to CoCos, we are also concerned that it is likely to be
several months until permanent rules are in place.

20.
We have therefore decided to exercise the option to make temporary rules to address the
risks to consumers of inappropriate distribution of these securities. The new rules will
apply equally to CoCos issued in the UK or overseas. We believe they will ensure more
comprehensive and consistent protection for consumers while moving to a more
transparent regulatory approach that gives greater certainty and predictability for firms.
They represent a development of the FCA’s prompt response to the risks identified in this
market, from an initial case-by-case approach to the introduction of interim standards
applying to all firms, to be replaced by permanent rules after the consultation process is
concluded.

21.
The Financial Services and Markets Act 2000 (FSMA) (as amended by the Financial
Services Act 2012) introduced explicit powers to make product intervention rules (s.
137D). Section 138M provides that the FCA may make product intervention rules without
consultation (and without complying with other requirements under FSMA, such as
conducting a cost benefit analysis) if it considers it necessary or expedient to do so to
advance the consumer protection objective or the competition objective (or the integrity
objective if the requisite order is made by Treasury). Product intervention rules made in
this way may last for a maximum of 12 months and are known as temporary product
intervention rules.

22.
In our statement of policy in relation to how we intended to use this rule-making power,
we said that the FCA’s main consideration will generally be whether prompt action is
deemed necessary in seeking to reduce or prevent consumer detriment.3 We consider
this intervention to be in keeping with our statement of policy and with the requirements
of s. 138M FSMA.

23.
We are introducing restrictions in relation to the retail distribution of CoCos as temporary
product intervention rules with effect from 1 October 2014 and lasting for 12 months.
The rules relate to CoCos eligible as either AT1 or Tier 2 (T2) capital under Regulation
(EU) No 575/2013 (the Capital Requirements Regulation or CRR).4 As explained above,
the restrictions will limit the ability of firms to distribute CoCos to retail customers: the
firm will first be required to check that the customer falls within one of the permitted
categories.

24.
The temporary restrictions will apply to the distribution of new issues and of investments
on the secondary market, including promotions to UK investors of securities issued
abroad.

25.
In September this year, we are planning to publish a consultation paper about proposed
permanent rules on CoCos. After we have considered the feedback, we aim to publish a
policy statement in Q2 2015, with final rules to be scheduled to take effect on 1 October
2015, when the temporary product intervention rules expire.

Modification of rules

26.
Temporary product intervention rules are by their very nature made without prior
consultation and thus will not undergo the usual process for testing draft rules and
receiving and considering feedback from the public before they are made. While every
effort has been made to ensure these temporary rules have the effect described in this
communication, we are aware of the possibility of unintended consequences.

3 http://www.fca.org.uk/static/documents/consultation-papers/fsa-ps13-03.pdf
4 Regulation (EU) No 575/2013

27.
As such, we would welcome comments from any firms, organisations or members of the
public who believe they have identified ways in which the drafting of the temporary rules
may depart from their intended effect. While inviting such comments should not be
perceived as amounting to a consultation exercise, we would particularly welcome
comments received before the rules come into force on 1 October 2014.

28.
We would also note that the waivers process is potentially available to firms subject to
the temporary rules. It provides a route for modifying the rules in specific or narrow
circumstances where they would not work as intended. As explained on our website, we
will consider granting a waiver if the firm is able to demonstrate that (a) complying with
the rule would be unduly burdensome or would not achieve its purpose, and (b) the
waiver would not adversely affect any of our operational objectives. Our operational
objectives are to secure an appropriate degree of protection for consumers, to protect
and enhance the integrity of the UK financial system, and to promote effective
competition in the interests of consumers.

If you have any comments you can send them in writing to:

Jason Pope or Leonor Dormido Jordá
Policy, Risk and Research Division
Financial Conduct Authority
25 The North Colonnade
Canary Wharf
London, E14 5HS

Email: Jason.Pope@fca.org.uk or Leonor.Dormido-Jorda@fca.org.uk

We will make responses available for public inspection unless the respondent requests
otherwise. We will not regard a standard confidentiality statement in an email message as a
request for non-disclosure.

Despite this, we may be asked to disclose a confidential response under the Freedom of
Information Act 2000. We may consult you if we receive such a request. Any decision we make
not to disclose the response is reviewable by the Information Commissioner and the
Information Rights Tribunal.

Annex 1: Considerations for the use of the temporary product
intervention rule-making power

Intended outcomes and links to FCA’s objectives

29.
The temporary product intervention rules are designed to advance the FCA’s objective of
securing an appropriate degree of consumer protection by preventing the distribution of
CoCos to consumers for whom they are unlikely to be suitable.

30.
Issuers in some other jurisdictions have used self-placement distribution models to sell
similar capital instruments to their retail clients. In some cases it appears that the
majority of sales, up to 75%, were to retail investors. The loss per customer in some
cases has been over 80% of their initial investment.

31.
If a CoCo is triggered, there is also likely to be a contagion effect to other instruments as
the market reacts. In one survey, for example, it was reported that, on average,
investors expect a 9% drop in prices across the market on the first deferral of coupons,
and a 15% drop in market prices following a conversion. 5 Therefore, ordinary retail
investors with holdings of instruments from different issuers may also face detriment.

32.
We are acting now to prevent detriment to ordinary retail investors in the UK. The FCA’s
regulatory approach favours intervention in problematic markets to prevent consumer
detriment occurring in the first place rather than to remedy it after it arises. Without the
introduction of these rules, we believe it is possible that ordinary retail investors in the
UK are likely to be exposed to instruments that are not appropriate for their needs and
which may lead to detriment.

33.
We are also taking into account our objective of promoting effective competition in the
interests of consumers. By aligning the ability of firms to promote these securities to the
consumers for whom they are most likely to be suitable, we believe our approach will
promote effective competition in the interests of consumers, rather than allowing firms to
compete for capital from consumers for whom these securities are likely to be not suited.

34.
The FCA statement of policy on the use of temporary product intervention rules sets out
as the key consideration that, in deciding whether the rule should be made as a
temporary product intervention rule, our main consideration will generally be whether
prompt action is deemed necessary in seeking to reduce or prevent consumer detriment
arising from that product, type of product or practices. The policy statement on the use
of temporary product intervention rules also lists a number of factors that the FCA will
take into account, as a minimum, when considering making a rule in this way. Below we
set out our assessment of those factors for this issue.

Whether prompt action is necessary

35.
Between 2009 and 2013, the amount of CoCos issued by banks is estimated to have
reached around $70 billion (approximately £40 billion).6 20.7% of this issuance was from
UK banks.

5 The Revolver, Macro Credit Research, 12 May 2014, RBS, http://ftalphaville.ft.com/files/2014/05/The-Revolver-
Cocos-Investors-call-for-standardisation-more-consistency-RBS.pdf
6 CoCos: a primer, BIS Quarterly Review, September 2013, Bank of International Settlements,
http://www.bis.org/publ/qtrpdf/r_qt1309f.pdf

36.
In the June 2014 Financial Stability Report,7 the Bank of England noted that European
issuance of AT1 has accelerated sharply over the past 18 months. The report estimated
that, if the largest four UK banks issued AT1 up to 1.5% of risk-weighted assets, this
would lead to additional issuance of around £22 billion (around £7 billion has been issued
to date).

37.
In a report earlier this year, Bank of America Merrill Lynch estimated the European AT1
CoCo market could grow to more than €150 billion by 2020. 8 The market is therefore
expected to grow rapidly in the coming years.

38.
Increasing issuance of CoCos to meet prudential capital requirements might lead to the
marketing of these instruments to ordinary retail investors, who would not be able to
assess the risks entailed adequately. Given the possible scale of potential detriment to
retail clients that might result, we believe that prompt action is necessary.

39.
Further, we note that it would be possible for UK entities to issue instruments in other
jurisdictions, avoiding our involvement in shaping prospective issues, then to market
those instruments to retail clients via a UK branch network.

40.
Making temporary product intervention rules avoids these risks and focuses sales on
those clients better placed to understand the risks and make informed investment
decisions. It also minimises the delay until these measures are in place. This approach
also adds certainty and transparency of our approach to the market, with greater clarity
than our existing case-by-case approach has been able to achieve.

Appropriate and effective means of addressing actual or potential consumer
detriment associated with a particular product or group of products

41.
We do not believe that CoCos are generally suitable for the retail market. While to date
we have protected the UK retail market from CoCo issuances using case-by-case
supervisory measures, the growing number of issuances is likely to put increasing strain
on this approach and cannot influence non-UK issuances.

42.
Securities presenting similar characteristics have caused significant detriment in other
jurisdictions. The temporary product intervention rules prevent this situation occurring in
the UK and limit retail access to those clients who are better placed to understand the
risks.

A proportionate and deliverable means of addressing actual or potential
detriment

43.
The temporary product intervention rules are focused on reducing risk to ordinary retail
investors, while still allowing other investors access to these securities. We consider this
to be a proportionate response to the risks of consumer detriment. Our previous work on
marketing restrictions on non-mainstream investments shows that it is a deliverable
means of addressing the risk.

7 Financial Stability Report, issue 35, June 2014, Bank of England ,
http://www.bankofengland.co.uk/publications/Documents/fsr/2014/fsrfull1406.pdf
8 Bank of America Merrill Lynch, Contingent Capital – what we think, 14 January 2014

Compatible with the FCA’s duty to promote effective competition in the
interests of consumers

44.
In making any rule, including temporary product intervention rules, the FCA seeks to
promote effective competition in the interests of consumers where doing so is compatible
with advancing its consumer protection objective (or the integrity objective). In
assessing the impact of the proposed temporary product intervention rule, we have
considered the following points:

• whether there is reasonable scope for the rule to promote effective competition in the
interests of consumers, for instance by addressing consumer behaviours that impair
their ability to benefit from competition, by reducing information asymmetries or by
correcting misaligned incentives

• whether the rule may have a negative impact on competition factors such as product
innovation and barriers to entry for new market participants

• whether any negative impact on competition factors is proportionate, having regard to
the aims of the rule

• whether alternative solutions may deliver the same intended outcome while having a
more positive impact on competition, and

• the overall effect of the proposed rule upon the operation of effective competition in
the market for financial services, having regard to the interests of consumers

45.
To exert effective competitive pressure, consumers need to assess quality and price
(value) adequately. As noted above, the information asymmetries apparent in the market
for these instruments are profound. Further, behavioural biases are expected to play a
significant role in this market were we to leave it unchecked. The current low interest
rate environment and the focus on finding yield, particularly by clients who only have
experience in cash savings, is likely to lead to a focus on headline rates without a
sufficient understanding of the nature and risks of the instruments or a fair assessment
of value for money.

46.
We do not consider that other solutions, such as additional disclosure, are likely to be
sufficiently effective in this sector, or to have a more positive impact on competition,
given the need for specialised knowledge and the highly complex, unfamiliar, and
untested, nature of these securities.

47.
For these reasons, we conclude that limiting access to CoCos is compatible with ensuring
that distributors of investments compete to promote suitable – rather than unsuitable –
investments to ordinary retail investors. On the other hand, these securities are more
likely to be suitable for high net worth and sophisticated investors in the retail market.
Those consumers are more likely to be able to engage effectively in this market without
suffering from information asymmetries to the same extent.

48.
We believe the rules will promote effective competition in the interests of consumers by
aligning the ability of firms to offer CoCos to those consumers for whom they are most
likely to be suitable in the retail market. We do not expect this to have a negative impact
on competition but it should prove beneficial by reducing the widespread concerns that
these securities might otherwise reach sectors of the markets for which they are
inappropriate.

49.
Overall, we expect the measures to improve consumer outcomes by limiting the scope
for firms to exploit information asymmetries and consumer biases. This will reduce firms’
ability to interest ordinary retail investors in securities that are unlikely to be suitable for
them. We believe this will make competition work more effectively in the interests of
consumers by helping refocus competition on the promotion of investments that are a
better match to the investors to whom they are marketed.

Supported by sufficient and appropriate evidence

50.
As a fairly new market development – and one that has been controlled to date in the UK
through FSA and FCA supervisory measures – there is no evidence of actual consumer
detriment in the UK. We consider, however, that there is a significant body of evidence
(as set out above) of the need to control the distribution of these securities to ordinary
retail investors.

Transparent in aim and operation

51.
We consider that the temporary product intervention rules are clearly drafted and easy
for distributors to interpret and follow. We also consider that introducing temporary
intervention rules provides legal certainty for issuers during the interim before
implementation of the final rules on which we will be consulting in due course.

Likely to be beneficial for consumers, when taken as a whole

52.
The approach we follow will protect ordinary retail clients but still allow retail market
access to these instruments, if consumers meet relevant requirements. Investors for
whom these are generally unsuitable will be protected, but investors for whom they may
be suitable will be able to access them. Nor will we prevent issuers from accessing a new
source of regulatory capital. As a whole, therefore, we believe that this approach will
prove net beneficial overall for consumers and the industry.

The impact on protected groups in the Equality Act and whether the rule
promotes equality and good relations

53.
In introducing retail distribution restrictions as temporary product intervention rules, we
aim to protect all ordinary retail investors, including those in the protected groups under
the Equality Act, by stopping retail distribution that is unlikely to be suitable.

EU considerations

54.
We consider our approach to be consistent with the ESA statements and relevant EU
legislation, including MiFID,9 the Prospectus Directive10 and CRD IV.11

•
MiFID prevents us from introducing sales restrictions but, while it has some
provisions relating to the conduct of marketing, it does not harmonise rules in
relation to marketing limitations and therefore we believe the introduction of
marketing restrictions in the manner proposed is consistent with MiFID. It is for these

9 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial
instruments and amending Directive 2002/92/EC and Directive 011/61/EU
10 Directive 2003/71/EC
11 Comprising the Capital Requirements Directive (EU Directive 2013/36/EU) and the Capital Requirements Regulation
(EU Regulation 575/2013)

reasons that, where a transaction amounts to MiFID business, the restrictions we are
introducing apply only with regard to financial promotions.

•
While the Prospectus Directive allows the free dissemination of prospectuses across
the EEA (and so we have included a specific exemption for firms disseminating
prospectuses), any ancillary communication (including a verbal communication,
leaflets, websites or other documentation provided at the same time) would be
subject to the marketing restriction.

•
CRD IV sets prudential requirements with which institutions must comply, which
includes requirements concerning CoCos. CRD IV does not impose requirements on
the retail distribution of these instruments; we therefore believe that the rules are
permissible under CRD IV.

55.
We have also considered the recent publications by the European Supervisory Authorities
with regard to CoCos.

•
ESMA recently published a Statement on potential risks associated with investing in
contingent convertible instruments. The Statement highlights the difficulties
presented for investors in correctly assessing the risks of this type of instruments. It
also informs investors of the different risks that these instruments present and asks
for a careful consideration of those to be made prior to their acquisition.

•
The reminder to credit institutions and insurance undertakings about applicable
regulatory requirements issued by the Joint Committee of the ESAs includes a
reference to past experience in Member States where institutions placed their own
capital instruments with retail customers.

Discussion with the Prudential Regulation Authority and the FCA Panels

56.
We have discussed our approach with the PRA and the FCA Panels.

Contextual considerations

57.
We have also considered the market context in which the rule would be introduced,
looking at the following points.

•
The potential scale of detriment in the market: as noted earlier, we expect the
amount of CoCos in the market to increase rapidly in the coming years. Left
unchecked, there is significant potential for these to be sold to ordinary retail
investors who may suffer substantial detriment in the future.

•
The potential scale of detriment to individual customers: we are concerned that
securities offered by banks that offer higher rates of return will be particularly
attractive to clients with most of their net wealth held in deposits. These clients may
invest high proportions of their money into the instruments and, as a result, could
lose substantial amounts in the event that an instrument triggers.

•
The social context: we consider the type of ordinary retail investor most at risk of
detriment to be people in retirement, who have built up substantial amounts of
money in savings accounts but who are now searching for better interest rates than
are available on cash accounts. These consumers may well be attracted by the high
headline rates of return and may be vulnerable to marketing material promoting the
investments on an unadvised basis, without understanding the additional risks they

would face. As a result, they may invest a significant proportion of their money in the
instruments of one or a small number of issuers.

•
The market context: as explained above, we are particularly concerned about the
potential for behavioural biases to drive unsuitable sales in this market. We regard
information asymmetries to be so pronounced and so difficult to eradicate that we do
not believe alternative approaches, such as requirements for enhanced disclosure,
more disclosure or for all sales to be advised would be sufficient to avoid detriment.

•
Possible unintended consequences: we do not consider it likely that the introduction
of the restrictions will have unintended consequences for capital raising. To date, our
supervisory approach has provided protections for ordinary retail investors without
damaging the ability of issuers to raise capital. We therefore do not expect there to
be substantial numbers of existing ordinary retail investors with exposure to CoCos.
CoCos may still be sold to investors for whom they are more likely to be suitable,
including professional investors or retail investors who are high net worth or
sophisticated. The rules are drafted in such a way that an ordinary retail investor who
does hold a CoCo may still receive advice from a regulated firm about whether the
investment remains suitable or should be reinvested. The rules prevent further
investment by ordinary retail investors; they do not stop firms helping customers
understand whether or not existing investments are suitable.

Compatibility with the FCA’s regulatory principles

58.
We have set out below why we believe our rules are compatible with our strategic
objective, advance one or more of our operational objectives, and how we have regard to
the regulatory principles in section 3B of FSMA. We have also considered whether the
rules will have a significantly different impact on mutual societies as opposed to other
authorised persons.

The need to use our resources in the most efficient and economic way

59.
The temporary product intervention rules will limit the retail distribution of complex and
risky securities to unsophisticated retail clients of ordinary means, who are at the
greatest risk of being mis-sold these securities, and thereby suffering consequential
potential detriment. The use of rules to achieve this is more resource-efficient than the
current case-by-case supervisory approach.

Proportionality of burdens or restrictions imposed on persons or on carrying
on an activity

60.
We consider that the benefits of the temporary product intervention rules are
proportionate; they protect ordinary retail investors but preserve firms’ ability to promote
these securities to professional, high net worth or sophisticated investors, for whom the
securities are more likely to be appropriate.

61.
The consultation paper setting out our proposals for permanent rules will include a
detailed cost benefit analysis. This will be published before the implementation of the
temporary product intervention rules.

The desirability of sustainable growth in the economy of the UK in the
medium or long term

62.
The temporary rules do not stop firms from using CoCos to raise capital but simply align
retail distribution with the type of consumer most likely to be able to understand the
risks and be able to afford potential capital loss.

The desirability of recognising differences in the nature of, and objectives
of, businesses carried on by different persons

63.
We recognise that firms selling these securities to institutional investors, high net worth
or sophisticated retail investors should be treated differently to those dealing with
ordinary retail investors and the rules we are introducing aim to do this, providing
appropriate flexibility.

The responsibilities of senior management

64.
To ensure compliance with restrictions, we include a focus on senior management
responsibility in the requirement for compliance directors to certify that the promotion
complies with the relevant restrictions. If we find systematic failures in a firm in the
future, we will be able to take enforcement action against senior management, if
appropriate.

The desirability of publishing information relating to persons

65.
We do not consider that the rules will have an impact on this.

The principle that we should exercise of our functions as transparently as
possible

66.
We have been transparent over our intention to intervene in this market. We announced
our plan to consult on marketing restrictions for CoCos in FCA PS13/3, published in June
2013. We noted that we may make a temporary product intervention rule while we work
on permanent rules.

67.
Furthermore, we are announcing the use of the temporary product intervention rules in
advance of their implementation. This will provide firms with time to update relevant
systems and controls.

The general principle that consumers should take responsibility for their
decisions

68.
Consumers can only be expected to take responsibility for their investment decisions
where they are in a position to understand the investments they are offered and the risks
to which their money will be exposed. We believe ordinary retail investors are unlikely to
be in a position to properly evaluate the risks and pricing of CoCos.

Expected effect on mutual societies

69.
In performing our regulatory activities, we must always consider the impact of new rules
on mutual societies.

70.
A particular challenge for mutual societies is that mutuality precludes raising capital by
way of issuing ordinary shares. This can lead mutual societies to issue alternative
instruments, such as CoCos, and there have been recent issues of CoCos by building
societies. Rather than convert to ordinary shares on a trigger event, these instruments
would convert to other types of equity instrument issuable by mutual societies, or
instead be written down.

71.
The risks that these instruments present to ordinary retail investors are high and we do
not consider there to be a need to treat mutual society issuances of CoCos in a different
manner to those issued by other institutions. The temporary product intervention rules
will, therefore, apply to such instruments issued by mutual societies as well as to those
issued by other entities such as banks.

72.
We do not expect the temporary rules to have a significantly different impact on issues of
CoCos by mutual societies as compared to other types of credit institutions. The high
minimum denominations of existing issues should mean that ordinary retail investors are
unlikely to hold these instruments. Our rules still allow for distribution to non-retail
clients, sophisticated retail clients and high net worth retail clients.

Legislative and Regulatory Reform Act 2006 (LRRA)

73.
We are required under the Legislative and Regulatory Reform Act 2006 (LRRA) to have
regard to the principles in the LRRA and to the Regulators’ Compliance Code when
determining general policies and principles and giving general guidance (but not when
exercising other legislative functions). We consider that our proposal is:

• Transparent: as set out above.

• Accountable: in making the restrictions as temporary product intervention rules, we
are making use of a power granted to the FCA in the Financial Services Act 2012 and
we are following the process set out in the policy statement on the use of temporary
product intervention rules. We will use the future consultation paper to seek feedback
on whether to make the rules permanent. The temporary product intervention rule will
last for a maximum of 12 months.

• Proportionate: as set out above.

• Consistent: our approach would apply in a consistent manner to all firms considering
sales of CoCos to retail clients.

• Targeted only at cases in which action is needed: we consider there is significant need
for the introduction of these measures.

Annex 2: Temporary product intervention rules

TEMPORARY MARKETING RESTRICTION (CONTINGENT CONVERTIBLE SECURITIES)
INSTRUMENT 2014

Powers exercised

A.
The Financial Conduct Authority makes this instrument in the exercise of the following
powers and related provisions in the Financial Services and Markets Act 2000 (“the
Act”):

(a)
section 137A (General rule-making power);

(b)
section 137D (Product intervention rules);

(c)
section 137T (General supplementary powers); and

(d)
section 138M (Temporary product intervention rules).

B.
The rule-making powers referred to above are specified for the purpose of section
138G(2) (Rule-making instruments) of the Act.

C.
This instrument comes into force on 1 October 2014 and will cease to have effect on 1
October 2015.

Amendments to the FCA Handbook

D.
The Glossary of definitions is amended in accordance with Annex A to this instrument.

E.
The Conduct of Business sourcebook (COBS) is amended in accordance with Annex B to
this instrument.

F.
This instrument may be cited as the Temporary Marketing Restriction (Contingent
Convertible Securities) Instrument 2014.

By order of the Board of the Financial Conduct Authority

Annex A

Amendments to the Glossary of definitions

Insert the following new definition in the appropriate alphabetical position. The text is not
underlined.


contingent
convertible
instrument

a financial instrument which meets the requirements for either:

(a)
Additional Tier 1 instruments under article 52; or

(b)
Tier 2 instruments under article 63, if the provisions
governing the instrument require that, upon the occurrence
of a trigger event, the principal amount of the instrument
be written down on a permanent or temporary basis or the
instrument be converted to or more common equity Tier 1
instruments;

in each case of Regulation (EU) No 575/2013 of the European
Parliament and of the Council of 26 June 2013 on prudential
requirements for credit institutions and investment firms and
amending Regulation (EU) No 648/2012.

Annex B

Amendments to the Conduct of Business sourcebook (COBS)

After COBS 4.13 insert the following new section. The text is not underlined.



4.14
Temporary product intervention rules

Temporary restriction on contingent convertible instruments

4.14.1
R
(1)
A firm must not

(a)
sell a contingent convertible instrument to a retail client in the
EEA; or

(b)
do anything that would or might result in the buying of a
contingent convertible instrument or the holding of a beneficial
interest in a contingent convertible instruments by a retail
client in the EEA.

(2)
The prohibition in (1) does not apply if the firm has taken reasonable
steps to ensure that one or more of the exemptions in COBS 4.14.2R
applies.

(3)
In this section a retail client of the firm includes a person who would
be a retail client if he were receiving services from the firm in the
course of carrying on a regulated activity.

(4)
The rules in this section cease to have effect on 1 October 2015.

Exemptions

4.14.2
R
Title
Type of retail client
Additional conditions

Certified high
net worth
investors

An individual who meets
the requirements set out in
COBS 4.12.6R, or a person
(or persons) legally
empowered to make
investment decisions on
behalf of such individual.

The firm must consider the
contingent convertible
instrument is likely to be
suitable for that individual,
based on a preliminary
assessment of that
individual’s profile and
objectives.
(See COBS 4.12.5G(2).)

Exempt
persons
An exempt person (other
than a person exempted
only by section 39 of the
Act (Exemption of
appointed representatives))
if the activity relates to a
regulated activity in respect
of which the person is
exempt from the general
prohibition.

Not applicable.

Certified
sophisticated
investors

An individual who meets
the requirements set out in
COBS 4.12.7R, including an
individual who is legally
empowered (solely or
jointly with others) to make
investment decisions on
behalf of another person
who is the firm's client.

Not applicable.

Self-certified
sophisticated
investors

An individual who meets
the requirements set out in
COBS 4.12.8R, including an
individual who is legally
empowered (solely or
jointly with others) to make
investment decisions on
behalf of another person
who is the firm's client.

The firm must consider the
contingent convertible
instrument is likely to be
suitable for that individual,
based on a preliminary
assessment of that
individual’s profile and
objectives.
(See COBS 4.12.5G(2).)

Solicited
advice
Any retail client.
The prohibition does not
apply provided all of the
following requirements are
met:
(a) there is no financial
promotion other than a
personal recommendation on
the contingent convertible
instrument;
(b) the personal
recommendation is made
following a specific request
by that client for advice on
the merits of investing in the
contingent convertible
instrument; and
(c) the client has not
previously received a
financial promotion or any
other communication from
the firm (or from a person
connected to the firm) which
is intended to influence the
client in relation to
investment in contingent
convertible instruments.
(See Note 1.)

MiFID or
equivalent
third country
business
other than
financial

Any retail client.
If the prohibited activities
amount to MiFID or
equivalent third country
business, that rule only
applies to the extent that the
prohibited activity is the

promotions
communication or approval
of a financial promotion.

Prospectus
Any retail client.
The prohibition does not
apply to the distribution of a
prospectus required under
the Prospectus Directive.

Issuers
Any retail client.
To the extent that the firm is
acting as issuer of a
contingent convertible
instrument, the prohibition
only applies to the original
issuance of the contingent
convertible instrument and
not to subsequent trading in
the secondary market.

Clearing,
custodial and
processing
services

Any retail client.
The prohibition does not
apply to the extent that the
firm’s activities relate to
clearing, registration or
settlement of transactions in
contingent convertible
instruments (or rights to or
interests in such
instruments), any back office
processing or reporting of
such transactions, or custody
of contingent convertible
instruments.

Indirect
investment
Any retail client.
The prohibition does not
apply in relation to a
beneficial interest in a
contingent convertible
instrument held from
participation in a regulated
collective investment
scheme, investment in a
non-mainstream pooled
investment, or membership
of an occupational pension
scheme.

Note 1
A person is connected with a firm if it acts as an introducer
or appointed representative for that firm or, if it is any
other person, regardless of authorisation status, who has a
relevant business relationship with the firm.

Note 2
See COBS 2.4 for rules and guidance on agent as client and
reliance on others.

Adaptation of rules and guidance to contingent convertible instruments

4.14.3
R
(1)
For the purposes of compliance with this section and with any
assessments or certifications required by the exemptions set out in
COBS 4.14.2R, any references in COBS 4.12 provisions to non-
mainstream pooled investments must be read as though they are
references to contingent convertible instruments.

(2)
If the firm is relying on the high net worth investor exemption, the
sophisticated investor exemption or the self-certified sophisticated
investor exemption for the purposes of compliance with COBS
4.14.1R, the statement the investor must sign should have
references to non-mainstream pooled investments replaced with
references to contingent convertible instruments.

(3)
The firm must give the retail client a written copy of any statements
that individual has been asked to sign as part of certification as a
high net worth, sophisticated or self-certified sophisticated investor
for the purposes of compliance with COBS 4.14.1R.

4.14.4
R
If a firm communicates or approves an invitation or inducement to acquire
or underwrite a contingent convertible instrument (or rights to interests in
that instrument) which is addressed to, or disseminated in such a way that
it is likely to be received by, a retail client, it must comply with the record-
keeping requirements in COBS 4.11.1R, adapted as follows:

(1)
references to non-mainstream pooled investments should be read as
references to contingent convertible instruments; and

(2)
references to COBS 4.12.3R should be read as references to COBS
4.14.1R.