The Canadian Securities Administrators have issued an updated notice concerning Principal Protected Notes, indicating that it believes ongoing regulatory initiatives will address its concerns about the product.

On July 7, 2006, the CSA published a notice and an Investor Watch which identified a number of regulatory concerns about PPNs, including: inadequate, overly complex and inappropriate disclosure in PPN information statements and marketing materials; compliance with know your client and suitability obligations by registrants in connection with sales of PPNs; use of PPNs as a vehicle for selling alternative investment products to retail investors; and, registrant referrals to purchase PPNs without a determination by a registrant that the referral is in the best interests of the client.

Since the publication of that notice, the CSA has engaged in consultations with representatives of: PPN issuers, PPN manufacturers and distributors, the Investment Dealers Association of Canada, the Mutual Fund Dealers Association of Canada, the Chambre de la sécurité financière, law firms, and the federal Department of Finance. Also, the last federal budget indicated that the government plans to introduce regulations for banks that issue PPNs, to improve disclosure.

The CSA says it is consulting with Finance about the proposed federal PPN regulations, which are expected to be published in the fall, and has provided comments on drafts of those regulations. “We understand that the proposed regulations will apply to all PPNs [whether linked notes or linked GICs] issued by federally regulated financial institutions,” it says, adding that the Financial Consumer Agency of Canada will be responsible for compliance and enforcement of the proposed federal PPN regulations.

“Based on the statements made in the budget companion document and our discussions with federal Department of Finance staff, we expect that the proposed federal PPN regulations will address our key disclosure concerns about PPNs,” the CSA says.

The CSA notes that a significant portion of PPNs are issued by Québec-based caisses populaires that would not be subject to the proposed federal PPN regulations. “Pending publication of those regulations, the Autorité des marchés financiers will consider the appropriateness of regulating PPNs issued by these entities,” it adds.

As for KYC and suitability obligations, the CSA reports that the IDA has confirmed that its regulations and by-laws apply to all dealings by its members. And, the CSA has initiated discussions with the MFDA regarding changes to its rules that would confirm the application of KYC and suitability obligations to dealings in PPNs by MFDA members and their representatives.

The CSA says it will continue to monitor the issue and sale of PPNs, but it believes that the existing regulatory initiatives will deal with its primary concerns.

“The concerns associated with the sale of PPNs as a vehicle for selling alternative investment products to retail investors will be substantially addressed by the improved disclosure and sales practices that should result from the changes contemplated,” it concludes, adding that proposed registration reform includes provisions dealing with referral arrangements.