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MiFID II complex debt defined quite simply

ESMA has issued a Final Report containing guidelines on which debt instruments and structured deposits will be considered “non-complex” under MiFID II. Article 25(4) allows firms to transact non-complex on behalf of customers without applying the Article 25(3) appropriateness test. The report follows the 24 March 2015 consultation paper, includes an analysis of its results and changes made in response. The report clarifies that the following will not be automatically classified as complex:

  • inflation-linked notes
  • debt instruments and structured deposits in a currency other than that of the debt/deposit’s jurisdiction
  • packaged debt instruments will be assessed according to the complexity criteria

The report contains a non-exhaustive list of categories and examples which would be classified as complex for the purpose of Article 25(4)(a)(ii), (iii) and (v) MiFID II:

  • Debt instruments embedding a derivative
    • convertible bonds,
    • index-linked bonds,
    • COCOs
    • callable/puttable bonds
    • credit-linked notes, warrants
  • Debt instruments incorporating a structure making it difficult of the client to understand the risk
    • return dependent upon a defined asset pool e.g. ABS,RMBS, CMBS, CDOs
    • return subordinated the reimbursement of debt held by others e.g. subordinated debt, certificates
    • issuer enjoys discretion to modify instrument cash flows
    • instrument lack specified redemption or maturity date
    • instrument has an underlying unusual or unfamiliar to the average retail investor
    • instrument has a complex mechanism to determine return
    • instrument is structured to allow less than the full repayment of the principal amount
    • instrument is issued by an SPV whose name may mislead as to issuer/guarantor
    • instrument with a complex guarantee mechanism
    • instrument with leverage features where the return or loss may be multiples of the initial investment
  • Structured deposits incorporating a structure making it difficult of the client to understand the risk of return
    • more than one variable affects the return
    • relationship between variable and return is complex
    • variable used in return calculation is unusual or unfamiliar to the average retail investor
    • the credit institution has the unilateral right to terminate the agreement before maturity
  • Structured deposits incorporating a structure making it difficult of the client to understand the cost of exiting before term
    • Exit cost is not a: fixed sum, or a monthly fixed sum, or a fixed percentage of deposit

The above guidelines represent a significant extension to the MiFID I complexity definition. The classification is scheduled to take effect 3 January 2017, although readers will be aware that this date is looking decidedly provisional.

 

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