Central Bank Dear CEO letter – MiFID Structured Retail Product Review - Supervisory Guidance
March 2023On 3rd March 2023, the Central Bank of Ireland (the “CBI”) published further Supervisory Guidance following the “Dear CEO” of April 2022, which outlined its findings of a review identifying issues in the marketing of complex investment products - Structured Retail Products (SRPs) - manufactured and distributed by MiFID investment firms.
The Supervisory Guidance supplements this letter and provides clarification to firms on how the warnings on use of a decrement index should appear, and the presentation of back-testing.
1. Use of decrement index – appearance of prominent wording
In April 2022, it was determined that one area of complexity was the use of decrement indices (where a fixed dividend is periodically subtracted 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).
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).
Firms should also keep in mind that, in cases where the SRP uses a fixed dividend deduction in the form of a fixed-point value (rather than a percentage), this "drag on performance" will be accelerated if the index drops below its initial level and that a sustained decline in markets will accelerate the decline in the value of the index.
2. Presentation of back-testing/overlapping simulations for ‘capital at risk’ SRPs
The Central Bank 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. The Central Bank is concerned with ensuring that the presentation of historical data is not misleading.
The Central Bank wants firms to avoid using a large number of overlapping simulations that show little, if any, capital losses as that has the potential to mislead clients about the likelihood of experiencing a capital loss. This is because using such a large number of overlapping simulations that show little, if any, capital losses could mislead clients about the likelihood of experiencing a capital loss given the largely positive market conditions in recent years.
The full Letter can be found through the link below: