United States: Product Intervention – A New Tool In EU Securities Regulation


"Product intervention" means that regulators have the power to ban or restrict certain types of financial instruments or activities, for example, by imposing restrictions on the type of investors to which certain financial instruments may be offered or by restricting the leverage that may be incorporated in a financial instrument. This power is provided for in the revised EU Markets in Financial Instruments Directive ("MiFID II") and the accompanying EU Markets in Financial Instruments Regulation ("MiFIR"), each of which became applicable in all EU member states in January 2018. As set out in more detail below, the European Securities and Markets Authority ("ESMA") has already exercised its new product intervention power with respect to binary options and contracts for differences ("CFDs").


Prior to MiFID II, EU investor protection efforts were mainly directed at improving the information provided to potential investors. The underlying assumption was that if investors are provided with sufficient information about financial products and issuers, they are in a position to make a rational decision on whether to invest in the product. Therefore, EU investor protection efforts have for many years relied on improving disclosures, for example, by expanding the amount of information required to be included in a prospectus, as well as by improving the way in which that information is presented, such as by requiring distributors to provide investors with key investor documents that summarize essential information about structured products concisely.

Product intervention may be regarded as a turn away from the "traditional" approach to investor protection, as it is based on the assumption that despite all of the improvements in offering disclosures and delivery of information, certain financial products may be so risky that investors may still not be able to make an informed decision. Another rationale for product intervention is that certain financial products may create risks for the financial system as a whole and should therefore be banned, irrespective of whether investors understand the risks of an investment in such products.


According to article 42 of MiFIR, the competent authority of each EU member may exercise product intervention powers in the relevant member state. In addition, according to articles 40 and 41, ESMA and (if restrictions are to be based on structured deposits) the European Banking Authority ("EBA") have temporary product intervention powers. These powers are temporary because if ESMA or EBA make use of their intervention powers, they have to review the prohibitions or restrictions they have imposed at least every three months. However, they may extend a ban or restriction an indefinite number of times. A competent authority of an EU member state may prohibit or restrict financial products or services on a permanent basis, but it has to revoke the prohibition or restriction if the reasons for the product intervention no longer apply. Since most types of financial products are distributed in more than one EU member state, we would expect that ESMA is more likely to exercise product intervention powers than the national competent authorities.

Generally, ESMA may only exercise its product intervention powers if these are required in order to address a significant investor protection concern or to address a threat to the orderly functioning and integrity of financial markets or commodity markets or the stability of the financial system in the EU. Also, existing regulatory requirements must not sufficiently address the threat. When ESMA intends to impose bans or restrictions on financial products or services, it has to consider a broad range of criteria that are set out in article 19 of Commission Delegated Regulation (EU) 2017/565. These criteria include, for example, the complexity of the financial product or service, the size or the notional of the financial instruments, the degree of innovation and the leverage incorporated in the product.


ESMA used its product intervention power for the first time in May 2018, when it decided to impose a prohibition on the marketing, distribution and sale of binary options to retail investors, beginning July 2, 2018. On the same day, ESMA also decided to impose restrictions on the marketing, distribution and sale of CFDs to retail investors, starting on August 1, 2018. These restrictions include, inter alia, initial margin protection (by limiting the permitted leverage of the CFD) and margin close-out protection (by requiring CFD providers to close-out a client's open CFD at 50 percent of the initial margin required to open the position) and negative balance protection (by imposing a limit of zero on a retail client's aggregate liability for all CFDs held by a retail client with a specific CFD provider). On September 21, 2018, ESMA decided to renew the aforementioned prohibitions and restrictions for binary options and CFDs.


Even prior to the application date of MiFID II and MiFIR, EU member states could invest their national competent authorities with product intervention powers. For example, Germany introduced these product intervention powers in July 2015. In May 2017, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, "BaFin") had already banned the marketing, distribution and sale of CFDs that provide for additional payment obligations to retail investors. Earlier, it had announced in March 2016 that it was considering prohibiting the marketing, distribution and sale of credit-linked notes ("CLNs") to retail investors. The BaFin finally refrained from imposing the ban after industry associations presented a self-commitment, which is aimed at protecting retail investors in CLNs. Pursuant to this self-commitment, issuers of CLNs shall, for example, issue only CLNs with a simple structure. This means that retail CLNs should only have a single reference entity. CLNs with multiple reference entities are only allowed if this results in risk diversification. In addition, retail CLNs must have a fixed or step-up coupon and a minimum denomination of EUR 10,000. The reference entities must have an investment grade rating and their shares or bonds shall be listed on an organized market, which means that the reference entity is subject to extensive statutory disclosure requirements. This example shows that product intervention powers may have a significant impact on the market, even if they are finally not exercised, as issuers have incentives to discuss with regulators and, if necessary, change the structure of their products.

Originally published in REVERSEinquiries: Volume 1, Issue 7.

Originally published October 23, 2018

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