SPA Conference: Proprietary indexes are on regulators' radar screen, lawyer warns

By Emma Trincal

New York, Nov. 13 - The use of proprietary indexes by issuers in the retail space is one of the latest red flags in the regulation landscape for structured products, said Anna Pinedo, partner at Morrison & Foerster.

The topic, among other regulatory issues, was brought up during a legal and compliance panel during the 9th Structured Investments Autumn-Expo 2013 Distribution Conference held in New York on Tuesday and sponsored by the Structured Products Association.

"Finra and the SEC are looking at proprietary indexes more," she said.

"There are a host of legal issues with proprietary index products."

Complicated algorithms

The Financial Industry Regulatory Authority brought up the issue last month in a report on conflicts of interest.

In the report, the authority said that the "sophisticated or complicated trading algorithms" could add to the list of concerns the regulator has already expressed about structured products in the past.

"This could become a more serious issue for a structured product the performance of which is linked to a proprietary index (created and maintained by the product issuer), as additional fees associated with the use of the index can be high and in some cases difficult to assess," the report said.

In addition, the limited history of those new indexes represented another area of concern, according to the report.

Establishing distance

"The more discretionary the index is, the more significant the issue is," Pinedo said.

"Ideally, you want to have a product that's rules-based. A third party can come in and act as an index calculation agent. You want minimum of discretion, especially when the index is very research-oriented.

"If you want to use a research-based index, you have to establish some distance between the provider of the research and the index provider. The group creating the index should be distinct from the issuing folks.

"With the popularity of proprietary index increasing, banks wanting to capitalize on the value of their research have to look at those aspects which represent important issues that have recently come up."

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