Limits are needed, the Fed said, because structured notes could complicate the work-out of a failed bank.
In the event of a failure and subsequent resolution, banks’ debt must be valued accurately and with minimal disputes, the Fed says in its proposal. But “structured notes contain features that could make their valuation uncertain, volatile, or unduly complex.”
Additionally, structured notes are often sold to investors who want exposure to a particular asset class, and imposing losses on them because a note issuer failed may create more obstacles to a resolution, the Fed states.
In comment letters earlier this year, financial industry associations argued that principal-protected notes should qualify as eligible debt under the plan since resolution values would be known in the event of a crisis.
In the meantime, big banks are setting up subsidiaries to issue the products because subsidiaries will not be subject to a cap on non-eligible liabilities, as the holding companies would be under the proposal.
In the end, banks may be able to maintain note issuance through these new subsidiaries, Ireland said.
The Fed’s proposal is just the latest new regulatory hurdle for the struggling structured-products industry.
Through the first half of this year, sales of structured products have fallen by a third from last year. Volume is now running at about a $40 billion annual pace, according to Structuredretailproducts.com, which tracks the industry.
Lack of volatility and the pending DOL rule have impacted volume, according to some observers. Structured notes were on the DOL’s initial hit list of banned products, although that list was dropped in the final rule.
But the DOL, like other regulators, has warned firms about the sale of complicated products like structured notes.