With the non-bank asset-backed commercial paper fiasco apparently on its way to resolution, it’s time for sober reflection on where we go from here.
There’s no doubt this fiasco has created a crisis of confidence. As Tony Fell, retired chairman of RBC Capital Markets and retired deputy chairman of Royal Bank of Canada, said in April, we’ve seen these crises before. They are driven by: greed in the financial services business; over-optimism and herd mentality; excessive leverage; borrowing short and lending long; flawed and excessive innovation; conflicted rating agencies; and regulatory failure. The crises reoccur because memories are short in the financial services business and market players get swept up in the euphoria of the day.
The ABCP situation has not been helped by the prevailing mantra that regulation should not stifle financial innovation. But as Fell said: “…it is now evident that financial innovation and the use of derivatives went way too far. Those [who] were structuring these new products did not know what they were making; those [who] rated them did not know what they were rating; those [who] were selling them did not know what they were selling; and those [who] purchased them did not know what they were buying.”
What a damning state of affairs! And the repercussions are endless. Meanwhile, there seems to be no slowing the creation and distribution of these little understood, seemingly innocuous structured products, many of which turn toxic in the investors’ hands. Investors are at the mercy of advisors who assure them these products are both appropriate and suitable. Often they are offered on an exempt basis — there are no prospectus disclosure requirements or registration or suitability requirements.
It’s obvious that there are shortcomings within the regulatory system — due, perhaps in part, to today’s products, which have outgrown it. How, then, should the regulatory system deal with this? What’s the role of the regulator?
In the case of principal-protected notes, the regulatory response of requiring principles-based disclosure is hardly adequate to address the fact that the likelihood of achieving any return higher than the basic nominal rate is remote. A similar concern exists with the so-called “accelerator series” of products that are tied to various indices.
Various regulators have taken stabs at addressing the relationship between distributors and individual investors — both generally and in relation to structured products. A lot of what they have said is motherhood but does not address the question of whether the product should be permitted to be offered to individual inves-tors in the first place.
Regulators do not want to get involved in “merit” regulation, but somebody needs to be able to speak meaningfully on behalf of investors.
Perhaps it’s time to create a statutory body similar to Britain’s or Australia’s Office of Fair Trading, with an initial mandate of assisting investors in assessing the merits of these structured products as well as negotiating changes in the terms of the offering to protect their interests. Also, this body, working together with regulators and ombudsman services, could be responsible for developing and maintaining a complaint resolution system that individual inves-tors could access. Another function would be to review and comment on proposals for changes in securities laws and to initiate proposals for securities law reform.
In the meantime, those responsible for ensuring that capital markets operate fairly need to focus on whether the education and proficiency requirements for advisors who sell these products have kept pace with the skills required to vet them adequately for appropriateness and suitability. It’s unfair to advisors to expect them to fulfil a task for which they may not be trained; it is contrary to the public interest to ignore the issue on the basis that the products are exempt products. IE