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A closer look at the FCA 'Thematic Review' on structured products

By Ian Lowes & Chris Taylor

The most recent thematic review of structured products, conducted by the FCA (TR15/2, March 2015: ‘‘Thematic Review of Product Development and Governance’’), focused on UK retail providers and their product design/development and governance processes, and has been issued alongside an ‘Occasional Paper’ (No.9, March 2015: ‘’Two plus two makes five – Survey evidence that investors overvalue structured deposits’’), which sought to stimulate debate about consumer behaviour, based on a survey assessing how investors react to certain structured deposits.

The Thematic Review detailed the FCA’s findings upon reviewing the processes of nine provider firms which manufacture and distribute structured products to their own or other retail customers and 14 banks which manufactured structured notes for issuers. Both structured deposits and capital ‘protected’ products were reviewed.

The Occasional Paper, written by two members of the FCA’s Chief Economist’s Department and a Professor of Psychology from Warwick University, sought to stimulate/provoke interest and debate on structured products by analysing the results of a survey conducted on 384 investors, that was designed to investigate how well investors understand and value structured deposits.

Some fair points, well made …

In opening its latest review of the industry the FCA stated that the structured product market is an important component of the financial services industry, serving individual savers as well as sophisticated investors, corporates and financial institutions, providing alternatives to deposits and/or investment funds, shares or bonds.

Broadly speaking, whilst some within the structured products industry might be frustrated that the latest FCA Thematic Review paper has swiftly led to some negative headlines, the general findings are not unreasonable and the fact is that anything that leads to better practices, better products and better consumer outcomes is to be welcomed.

The main message from the Review is that its work with the provider/investment bank firms has identified that more effort is needed by firms to: i) match product design with the better identified needs of better targeted customers, ii) demonstrate product value through more robust stress testing, iii) provide clear and more balanced product information to customers, regarding features, returns potential and risks, iv) improve product governance through the product lifecycle.

Considerable focus also centered upon the FCA’s increasing expectations of provider / issuer governance of distributors, including advisers, targets the right products to the right types of distribution, ensuring that distributors are equipped with sufficient information to understand and therefore advise upon products appropriately, as well as monitoring the use of products to identify if the end customers match the target audience identified in the design process.

Frustration with FCA conflation…

One disappointment, from the perspective of provider firms and issuers operating distribution via the Independent Financial Adviser channel, and from the perspective of independent advisers, is that the FCA has indiscriminately bundled in the practices, processes, products and principles of issuers operating in cahoots with high street institutions to sell products that wouldn’t pass muster amongst IFAs today.

This conflated approach is frustrating – as so much progress has clearly been made in the IFA channel, following the previous action, rules and guidance of the regulator, since 2009, whilst the fines imposed on the Yorkshire Building Society and Credit Suisse, as a result of their product and misleading financial promotions, are as recent/current as last year.

Both the Thematic Review and the Occasional Paper therefore seem to lack the high level of targeting that the regulator expects of providers, issuers and advisers, in failing to adequately identify and show awareness of the differences between the processes, products and standards that are clearly evident in the professional independent advice channel (especially since the last Review and 2012 Finalised Guidance) and those seen in high street institutions, such as banks and building societies.

The Credit Suisse / Yorkshire Building Society products, that attracted the regulator’s attention and the fines, were of the ‘Cliquet’ variety, the most complex product type identified in the Review – and a product type generally shunned by IFAs, for being convoluted, complicated, opaque and unlikely to achieve the stated maximum returns potential. These products were lambasted by certain financial advisers when they were first launched, for the same reasons that the regulator took action over, later in the game. This clearly contrasts with the products sold through the independent adviser market, which have far clearer potential outcomes.

A further frustration with the Review is that structured deposits and capital ‘protected’ products at the ‘higher risk end of the spectrum’ were focused on. Product information from the providers in the review was used to assess the complexity of a sample of these products offered in early 2013 to retail customers. The FCA’s analysis suggested that most of the structured products in the sample were of ‘medium’ or ‘high’ complexity.

In the same way that you cannot say every mutual fund provides appropriate returns for the risk taken on, neither does every structured product necessarily equate to a good risk/return proposition.

Credit where credit is due / scrutiny and regulatory attention where it is needed …

A large proportion of the products recommended by adviser firms across the IFA sector have been amongst the simplest structures and have delivered exceptional and consistent returns over the years, against a backdrop of challenging and changing market conditions.

It’s the less well-designed structured investments that negatively impact on the whole sector. The fact of the matter is the distribution channel that has often been the biggest red flag, flapping in the wind for the regulator to see, is banks and building societies selling low value products, through low calibre branch ‘advisers’, to captive customer bases.

Read Ian Lowes' & Chris Taylor's article on the 'Behavioural Survey' as part of the FCA's review.