CNB to crack down on sales of bonds to non-professional clients
The Czech National Bank (CNB) issued Supervisory Benchmark No. 2/2019 on acquisitions of investment instruments by clients or investment funds, tightening the rules of acquiring complex investment instruments (namely corporate bonds) by so-called non-professional clients. The CNB is thus responding to the increasingly common practice of small and medium-sized enterprises and recently also start-ups that raise funds by issuing debt instruments that are very often acquired by non-professional clients.
One of the problems the CNB identified was the inadequate pricing of the offered investment instruments. Quite often, they are priced at fair value, which is determined based on the prices at which identical assets and liabilities are traded in active markets. Yet, debt securities offered by many start-ups are in fact not traded.
According to the CNB, the risk associated with the offered investment instruments is not adequately classified either. The target market setting should always also reflect any additional factors affecting the non-professional clients’ ability to assess risks (such as age, health, marital status, etc.). All information obtained then has to be assessed in a structured and logical manner to prevent offering unsuitable instruments.
When providing services that are subject to a proportionality test, securities brokers have the primary responsibility to set up the platform so that the instruments are not distributed to clients not matching the risk profile. The CNB has explicitly stated that merely formal compliance with the requirement to apply the proportionality test does not suffice. If securities brokers have any doubts whether their platform is visited by clients with an adequate risk profile, they for prudential reasons should not offer the product at all. In the future, a system where a high number of clients refuses to provide information needed for the proportionality test will also not be considered having been properly setup.
Although viewed from a different perspective, the same topic was recently also on the agenda of the Ministry of Finance, which prepared a corporate bond scorecard. This scorecard is meant to help investors, mainly non-professional clients, in their initial assessment of the suitability and risk level of the respective issue and issuer. This is also bound to raise client awareness of these factors.
It seems that bond issues are currently under scrutiny by a number of institutions, even on the EU level. On the other hand: if this way of obtaining finances is to become a viable alternative to the traditional types of funding, the conditions of its utilisation have to be transparent. And any enlightenment in this respect is welcome.