Structured products

1. Structured products Eystein Kleven Head of Securities Institutions Section Structured Products Europe 2008, 11-12 November 2008

2. Contents • Introduction • Which challenges have we seen? • 2.1. The market strength of distributors • 3. What has been done? Measurements: • 3.1. Regulatory changes and development • 3.2. Supervision • 3.3. Conduct of business rules – Kredittilsynet’s interpretation

3. 2.1. The market strength of distributors The financial instruments market Issuers of structured products National/ regional distributors Investors/ clients Investment advice/sale Different financial instruments Complex structuring Investment advice /sale Premise provider Investment advice/sale

4. 3. What has been done? • Kredittilsynet’s questionnaire among 15 banks regarding structured products, including • Historical information, including information on return/profit • Structured products offered in today’s market • Marketing of structured products • Education requirements and training provided to investment advisers/sales personnel • Financial incentives for the advisers/sales personnel • The financial institutions income related to structured products • Result: • Calculations of yield for 350 structured products with due date before the third quarter in 2007 and subscription date from1997 illustrated that most of the equity financed and debt financed investments did not generate additional yields compared to an investment without risk.

5. 3.1. Regulatory changes and developements • Circular 15/2006 containing guidelines on information which should be disclosed in connection with the sale of structured products (followed Circular 4/2004) • applies to investment firms in addition to the requirements in the Securities Trading Act and Securities Trading Regulations • Circular 4/2008 containing changes to the Regulations of 25 September 2006 No 1317 laid down by Kredittilsynet pursuant to the Act on Financing Activity and Financial Institutions • a number of the provisions concerning investor protection in the securities regulations applies to financial institutions when they undertake sales and advising related to structured products (deposit-based structured products and index-linked bank deposits) • Category • Structured products are deemed to be complex financial instruments • Kredittilsynet’s assessment • Kredittilsynet presupposes that the institutions should not sell structured products or other complex products to customers who cannot be reagrded as professional investors. Non-professional investors will normally not have the necessary experience and knowledge to understand the risk involved. • Often complex and comprehensive cost elements are included so that yield is likely not to meet client’s investment goals.

6. Volumes 2005 – aug 2008 Structured products sold by banks Equity financed Debt financed Bn NOK

7. 3.2. Supervision • Kredittilsynet has conducted 10 on-site inspections of investment firms with authorisation to provide investment advice. The on-site inspections has revealed a series of infringements to the Securities Trading Act, including: • The investment firms have not reccomended the products that offer the best terms for the client • The investment firms have reccomended products where the associated total transaction costs have served to significantly reduce the yield-potentialof the investment • The investment firms have included sales commissions that are unreasonable, relative to the value the investment firms have provided for the clients

8. 3.3. Rules (norms) for good business conduct • The investment firm must offer the best of comparable products • The investment firm must have sufficient competence on the available products in order to make comparisons relative to risk, expected yield, costs, liquidity etc. This comparison must be made relative to important general measurement criteria. The investment firm, by its nature as an advisor to the client and professional middle-man, is independantly responsible to perform this evaluation. The investment firm has a duty to examine which products are available in the market, and which would offer the best terms for the client.

9. 3.3. ..cont. • The transaction costs can not significantly reduce the potential yield of the investement • The investment firm must ensure that there is a reasonable relationship between the total costs and the amount invested, so that the potential yield is reasonable compared with alternative investments, as seen from the client’s perspective. • The ratio of paid-in investment capital that goes to the investment firm must be reasonable relative the value the investment firm has contributed • Good business conduct rules dictate that the client’s best interests must be adhered to, which means that the margins exacted by the investment firm can not be unreasonable. One must here look to the margins being reasonable relative to the value contribution from the investment firm, for example where the investment firm has assumed risk in the transaction or in the development of the product.