Insights Blog

The Central Bank has clarified two aspects of April 2022 Dear CEO letter to investment firms on MiFID structured retail products (SRPs).   These relate to how the warnings on use of a decrement index should appear, and the presentation of back-testing

For our analysis of the April 2022 letter, read our insights here: Structured Retail Products: Central Bank sets out its expectations and next steps for investment firms.

Use of decrement index – appearance of prominent warning 

The use of decrement indices (where a fixed dividend is periodically deducted from the underlying index and which can act as a ‘downward drag’ on performance where it is higher than the actual dividend paid, and in particular where the index falls below its initial level) was identified as an area of particular complexity in April 2022. 

Last week’s letter clarifies that the prominent warning must appear (in a separate text box) “on the front cover of the marketing material or brochure and on the page on which the decrement index is described in further detail“. 

The letter provides two sample warnings (one for the front page, and one for the page that describes the index in more detail). 

The letter also confirms that where the SRP uses a fixed dividend deduction in the form of a fixed point value (rather than a percentage) firms should bear in mind that this ‘drag on performance‘ will be accelerated if the index falls below its initial level, and that a sustained fall in markets will accelerate the decline in the value of the index.

Presentation of back-testing/overlapping simulations for ‘capital at risk’ SRPs

The Central Bank is focused on ensuring that the presentation of historic data isn’t misleading, and noted that if a firm uses past performance representations covering periods of positive client outcomes, that may not accurately reflect the likelihood of a client suffering a capital loss in the future. 

In light of the predominantly positive market conditions in recent years, and while the Central Bank is happy for firms to continue to show the past performance of the underlying asset over an “appropriate period“, the Central Bank wants firms to avoid using a large number of overlapping simulations which show little, if any, capital losses as that has the potential to mislead clients about the likelihood of suffering a capital loss.  

If you would like to discuss the above in more detail, please get in touch with any member of our market-leading Financial Regulation Group.

“The sale of SRPs and the increasing complexity of products offered by MiFID investment firms in the retail market have been a priority focus for the Central Bank in recent years….SRPs are complex products, and while they are fit for some experienced investors, we are of the view that many are not suitable for investors with a low risk appetite or who are inexperienced in financial markets.”