The decision by the Financial Services Authority (FSA) to publish guidance on what firms should consider when designing and marketing new structured products, has placed renewed scrutiny on this controversial investment product.
Offered by high street banks, insurers and investment firms, structured products are fixed-term investments that offer investors a predetermined return profile based on specific circumstances related to an index or underlying assets.
The collapse of Lehman Brothers during the global downturn placed these investment plans under greater regulator scrutiny, after it emerged that Lehman's was the counterparty to a number of structured product plans. The latest company falling foul of structured products is Credit Suisse - the company's UK arm was fined £5.95m by the FSA for mis-selling more than £1bn-worth of complex structured products to private banking clients.
The FSA review
Despite this somewhat tainted past, structured products have been rising in popularity as investors, wary of a volatile stock market and low returns on cash, seek out investment products that offer more predictable returns and an element of capital protection.
The FSA is concerned that the growing number of structured product sales, as well as increasing product complexity, is placing a strain on providers' systems and controls - leaving investors open to the risk of being mis-sold products. In response, the watchdog assessed seven major providers of structured products, collectively responsible for around 50 per cent of all structured products in the UK retail market, looking at how these firms were designing structured products, identifying their target markets and how they handled post-sales responsibilities.
The FSA has now published guidance for firms to consider when designing structured products and dealing with the after-sales process. "Many of the problems we found with the product design process were rooted in the fact that the firms are focusing too much on their own commercial interest, rather than the outcomes they are delivering to consumers," said Nausicaa Delfas, the FSA's head of conduct supervision.
The industry response
While the new guidance proposals are open for consultation until 11 January 2012, the response from the industry has largely been positive.
"It is great the FSA is focussing on the issue of product providers designing products with more attention to the commerciality than suitability. Obviously this is long overdue in the investment industry as a whole - as the Arch Cru debacle illustrates," says Clive Moore, managing director of IDAD Ltd.
Ian Lowes of CompareStructuredProducts.com says that while he agrees with the guidance in principle, he believes the point regarding products being created for the providers' interests rather than those of the consumer is too much of a generalisation.
"Innovation in the structured product market is not necessarily a bad thing, and providers creating different styles of products dependent upon market conditions gives variety to the market and can help to drive competition, which is also good."
However, Mr Lowes adds that he hopes and expects to see the end of products linked to indices that have been created solely for the purpose of providing the underlying measure for the product and also the poor products that are pushed onto unsuspecting customers "particularly at bank branch level".
The good and the bad
While the FSA guidance should not be at the expense of choice and innovation, there is no disputing that not all offerings are created equal within the structured products arena. Take the Leeds Building Society Capital Growth Account 8, as an example. This account comes with extremely complex terms - every six months throughout the six-year term, the movement in the FTSE 100 is observed and that movement, subject to a maximum rise or fall in the index of 4 per cent in any six months, is added up and the cumulative total (subject to a minimum of 10 per cent) is added to the original capital at maturity. Confused?
Thankfully there are some more attractive offerings out there, although many can only be bought via a financial adviser (another source of controversy, since the adviser is paid commission on the sale that is not always transparent). Mr Lowes picks out the Aviva Defined Growth Fund 2 which benefits from having six counterparties and a potential 9 per cent gain for each year held. It is linked to the FTSE100 and has a 50 per cent barrier, observed at close of business each day. Some capital will be lost if one of the counterparties defaults or if the FTSE is lower on all six anniversaries and falls more than 50 per cent during the term.
He also likes the Incapital Europe Digital Growth Plan – Defensive Series 2 which offers a 30 per cent gain at the end of the 4-year term, provided the FTSE 100 is no more than 30 per cent below the initial level at maturity.
An or product can deliver defined growth at a set point earlier than the maturity date, if specific criteria are met. An attractive offering in this space is the Morgan Stanley FTSE Kick-Out Growth Plan 14, which offers a 65 per cent gain after three years if the FTSE 100 is at least 10 per cent above the initial level; or, if not, twice any rise in the index after six years, uncapped. A loss will occur if Morgan Stanley defaults or if the FTSE isn't 10 per cent up after three years and is more than 50 per cent down at the end of the six years.