The FSA says its research shows financial promotions for products offering income, capital growth or capital security can be complex and difficult to understand. It is therefore proposing that firms selling ‘structured capital-at-risk products’ (scarps) – an investment that provides a specified level of income or growth over a fixed investment period but do not provide a guarantee on the return of initial capital – be required to provide consumers with risk warnings and send their customers periodic statements.
“Our concern is heightened by the fact that relatively few ‘scarps’ are sold as a result of consumers receiving advice,” says the FSA. “If consumers are not getting personally tailored financial advice, then an adequate explanation of risk is particularly important as they will be relying solely on the literature they receive.”
The FSA adds: “We think firms promoting or selling scarps should clearly set out the terms of the investment at the outset. In particular, we think promotional material should include information about the amount of capital an investor can expect to receive back at the end of the investment term. This should apply regardless of the way the product is distributed. We also consider that customers should get regular information about the performance of these products.”
But not all market participants agree with the FSA proposals. The Association of Private Client Investment Managers and Stockbrokers (Apcims), for instance, which represents 223 companies with some £250 billion under management, questions the need for the new rules.
“Firms warn that repeatedly providing investors with risk warnings increases the probability that the consumer will not read them or heed their contents,” says Katharine Green-Armytage, head of compliance at Apcims, in a letter to the FSA. The FSA also proposes that direct-offer financial promotions for scarps offering a specified level of income include a factsheet written by the FSA titled: High-income products – Make sure you understand the risks.
“It is likely that a sophisticated investor will be unimpressed by the simplistic explanations set out in the FSA factsheet,” complains Green-Armytage.
According to independent website StructuredRetailProducts.com, which tracks developments in the UK structured product market, investment sales declined last year partly as a result of continuing fallout from maturing precipice bonds. The website says the UK structured retail products market fell by 15% in 2003, from £6.28 billion to £5.36 billion.
In September, the FSA fined UK bank Lloyds TSB £1.9 million for what it described as a “number of unsuitable sales of a high-income equity-linked bond” – also known as precipice bonds. The fine related to the selling of ‘Extra Income & Growth Plan’ products that are due to mature this year. The products were linked to the performance of a basket of stocks, offered relatively high coupon payments but came with no capital guarantee.
Lloyds Treasury Services structured the investments as a basket of put options with a barrier set against each stock. The effect was a down-and-in barrier product, with the investor selling put options for premium that funded the high – relative to the market rate – coupon payments (Risk September 2003, page 12).
In conjunction with the FSA’s fine, Lloyds also paid £98 million in compensation to investors on a total of 22,500 sales. Meanwhile, in December the FSA fined investment company Chase de Vere £165,000 for offering misleading direct offer promotions on high-income and precipice bonds.
An FSA spokeswoman declined to comment on the implications of any new rules.