The new PPN rules
Earlier this month, the federal government released new regulations that are intended
to provide investors with more information on principal-protected notes (PPNs).
The question is whether the rule changes will be enough to reduce the flood of
money pouring into these questionable securities.
I have written about PPNs on several occasions and devoted most of a chapter
to them in my book Sleep-Easy Investing so I hope I have made my position
clear. I don’t like them and I don’t recommend them. As a general
rule, they are overpriced and over-promoted. These notes became popular as a
financial security blanket for psyched-out investors in the aftermath of the
2000-2002 bear market. They have grown into a multi-billion dollar business,
generating huge profits for promoters and brokers and, in most cases, below-average
gains for investors. Perhaps most important, they are most certainly not risk-free,
contrary to the general perception.
Until now, PPNs have been largely unregulated as they have been viewed as banking
products rather than as securities. But now Ottawa is changing the rules, at
least as they apply to institutions under its jurisdiction, such as the major
“The first generation of PPNs were simpler financial instruments, with
returns linked to the performance of an index,” explains the Finance Department
backgrounder. “The increasing variety and complexity of such products
can make it difficult for the average retail investor to fully understand the
risks, fees and potential returns.”
That’s an understatement if there ever was one. Some of the PPNs being
offered today calculate their returns on formulas that only a mathematician
Under the new regulations, which take effect on July 1, financial institutions
will be required to supply investors with complete information, both in writing
and orally, on such matters as “the term of the note, any charges and
their impact on the interest payable, how interest is accrued, any limitations
in respect of the interest payable, and any risks associated with the note.”
The information must also be posted on their websites and must be presented
in clear language.
This sounds good and is certainly a step in the right direction. But we need
to see how the regulations will be applied in practice. Moreover, will investors
pay any attention or will they ignore the documentation (as many do with mutual
fund prospectuses) and instead be swayed by the “risk-free” sales
pitches they’ll continue to hear?
PPN issuers will also be required to provide information on the current value
of the security to enable investors to monitor results. However, there is a
huge loophole here. Performance results only need to be produced “on request”.
Why so restrictive, we might ask. Mutual fund companies report their results
on a daily basis (or weekly in a few cases) and these are published on sites
like this one so that anyone can view them. Why aren’t PPNs to be held
to the same reporting standards?
Give the government points for effort but I am sceptical that these new regulations
will be strong enough to make a difference. Once they come into force, I’ll
take a close look at the information that’s offered to investors and comment
Photo ©iStockphoto.com/Feng Yu