Structured Products & Serious Advice - TECHNICALLY SPEAKING November 09
The past few weeks has seen a plethora of 'breaking news' headlines that has certainly sparked interest - especially for those of us wearing a regulatory hat. In one day alone industry email bulletins told us: 'three adviser firms in trouble over structured products'; 'advisers may have to outsource to structured product specialists'; 'structured providers accused of marginal changes following Lehman collapse' and last, but not least, 'adviser knowledge gap at heart of structured product failings'.
With the stories' obvious and recurring theme, it serves as a very real reminder that following the collapse of Lehman Brothers on 11th September last year, the structured products debacle will not just be swept under the carpet. The prompt for this latest flurry of interest was the FSA's recent review into the quality of advice on structured investment products.
The FSA report specifically centred on the findings from a detailed review on the quality of advice given to consumers to invest in structured investment products backed by the late lamented Lehman Brothers - from November 2007 to August 2008.
This latest review needs to be applauded for the speed of process and the issue of the final findings in this instance. The report was also helpful in re-stating some clear examples of what the Regulator considers to be good and poor practices in giving advice to customers on structured investment products. For example, the comments made by Dan Waters, head of conduct risk at the FSA, who was quoted as saying:
"Given the failings we have come across in the marketing and selling of these products, today we are setting out a package of robust measures to help those who have lost money. We are also taking decisive action to address issues in the wider structured products market to ensure that all future investors will be treated fairly".
More importantly he went on to say, "and we will not hesitate in taking action if firms do not take sufficient steps to respond to our concerns".
The contents of the report are very explicit. And it was good to see that in conducting this review, the FSA has specifically stated that in applying its methodology to the period prior to the Lehman's collapse, they also took into account the degree of due diligence that would have been considered reasonable for firms and advisers alike to have undertaken at that time. And, very importantly, did not apply the benefit of hindsight to the review process.
In total, the latest FSA review considered 157 sales at 11 firms and identified "significant" levels of unsuitable advice within nine of the 11. Exposing consumers to an "inappropriate" level of risk was cited as the biggest problem and indeed this was the reason given by the FSA for 67 of the 73 cases being rated 'unsuitable' and subsequently failed for this reason.
According to the Regulator, the failings suggest "fundamental flaws" in the core principles of investment advice which "cannot be solely attributable to any deficiencies in plan managers' literature".
As a result of these findings, three advice firms in the FSA's sample have now been referred to enforcement for giving unsuitable advice, while other firms must conduct a past business review.
When recommending structured investment products, the factors that the FSA expects advisers to consider include, but are not limited to, the following:
- Whether the customer has sufficient emergency funds
- The customer's timescale for investment
- Whether the customer has a potential need for liquid capital during the period of investment and, if so, whether capital has been set aside for this purpose
- If the investment is designed to provide a set return on a set date to meet a future need for money but the contract has the potential to mature early, what this may mean for re-planning, re-investment, and, hence, potential additional expense for the customer
- Whether the customer has any existing liabilities that may best be repaid before considering investment
- The implications of recommending a fixed-term product that cannot be cashed in according to market sentiment
- The suitability of additional product features such as early kick out
- The risk profile of the underlying investment indices and implications of a product linked to more than one index
- Any level of gearing on the product
The Regulator has now publicly stated that it takes the view that structured investment products are unsuitable for customers who do not want to take any risk with their capital - or have no capacity for loss. As advisers, we must all take very serious heed of this guidance.
The above bullet points only represent a taster of the key points addressed in the final review; but importantly the report also looks into the issues of due diligence requirements for the assessment of counterparty risk; ensuring that all firms have appropriate systems and controls in place to regulate the sales of structured investment products.
In fact counterparty risk features highly throughout the document. And given the failure of an investment grade counterparty such as Lehman's, advisers and firms are now required to undertake a much higher degree of due diligence when recommending products with counterparty risk and to consider more carefully how this relates to each customer's attitude to risk.
The assessment for due diligence purposes of the counterparty will involve:
- Consideration of the number of counterparties underlying a single structured product
- The location of the counterparties (e.g. UK based, Offshore US etc).
- The relative financial strength of the counterparties
The financial services industry cannot take this new guidance lightly given the seriousness of the failings which have been identified. There is clearly still much work to be done in this area to ensure that customers receive appropriate advice in what is certainly a specialised market.
There is no doubt the place for structured products in the investment market is deserved of a debate in its own right and one which is likely to rumble on for some time. For now, however, it is important that we take serious note of the review findings and work accordingly to address the issues which have been bought to everyone's attention. As professional independent financial advisers, our reputation and the reputation of our industry depends on it.
* Reproduced courtesy of Professional Adviser