ASIC releases report on structured products disclosure

ASIC has recently released a report¹ summarising ASIC’s key findings following a review of 64 product disclosure statements (PDSs) for structured products.

ASIC’s report is a useful tool for issuers of structured products (including capital protected products, deferred purchase agreements (DPAs) and warrants) because it provides PDS guidance in relation to a number of areas of regulatory focus.

This update is a summary of the report’s key points of interest for structured product issuers.

General disclosure issues

• Diagrams and examples: Issuers are encouraged to use diagrams and realistic examples to give ‘clear and effective’ disclosure. ASIC considers that:
  • without diagrams, graphs and other user-friendly visual aids, the disclosure of difficult or complex concepts may be defective
  • worked examples may be needed for effective disclosure, particularly where complex formulae are used in relation to the product 
  • the worked examples should use consistent and reasonable assumptions and should illustrate best and worst case scenarios, and
  • issuers should consider if an assumptions sensitivity analysis is needed, to illustrate the effect of variations in the assumptions.
• Defined terms: ASIC is concerned that disclosure is not effective where a PDS uses lots of defined terms and these are defined throughout the PDS. To address this concern, issuers are encouraged to:
  • use defined terms judiciously and keep them in a glossary, and 
  • identify prominently at the front of the PDS how defined terms will be used and that they can be found in the glossary.
• Equal prominence to benefits and risks: ASIC reiterated its policy (in RG 168) that risks and benefits disclosure should be given equal prominence. 
• Care in comparisons: a PDS should not include the past performance of an index or another product unless they are comparable to the product offered, and any material differences between them should be explained. 
• Feeder funds: ASIC expects a PDS for a feeder fund to fully disclose the investment strategy of the underlying fund, the risks of the additional feeder fund layer and any jurisdictional risk in relation to the underlying fund.

Specific disclosure issues

• Fully disclose any limitations on capital protection: Issuers are expected to fully identify any limits on capital protection and any capital protection risks. ASIC would like to see more PDS disclosure in relation to:
  • the events triggering an early maturity of a DPA, any discretions the DPA issuer has following those events and how the discretions will be exercised, so that investors can assess the likelihood of and effect of early maturity
  • where a bond and call structure is used, the percentage of the application monies invested in the bond to give effect to the capital protection (because this is relevant to the investment’s risk/return profile), and 
  • the time value of money. ASIC commented that examples (which would need to assume a rate of inflation) to illustrate the time value of money would be useful in relation to the capital protected amount.
• Better break costs disclosure: ASIC suggests that break fee disclosures need to be improved and that, at a minimum, a PDS should:
  • state that break costs are significant and are therefore a risk
  • state that an estimate will be provided to investors on request at the time they request early maturity, and
  • describe the main factors affecting the calculation of break costs, eg the cost of unwinding hedges.
  
  Issuers are asked to consider whether it is appropriate to include a broad indication of the amount of the break costs, such as a range expressed as a percentage. We anticipate that a meaningful range may be difficult to identify and that disclosure in relation to the factors affecting the amount of the break fees may be more practical. 
• Explain counterparty risk: Issuers are expected to clearly and prominently explain counterparty risk and provide relevant financial information so that investors can assess this risk. In practice this means that PDSs should:
• identify where the counterparty risk arises. In addition to the issuer’s obligations, does counterparty risk arise in relation to the issuer’s hedging contracts or in relation to a guarantor? and
• include or refer investors to relevant financial information about the relevant counterparties.

Endnotes

1. The full report is available on ASIC’s website.

More information

For information regarding possible implications for your business, contact