Consumers overestimating returns from structured investment products by almost 10%, says FCA

Consumer research commissioned by the FCA found that many overestimated the returns from specially-designed structured products by almost 10% over a five-year period, and tended to choose them over risk-free fixed-term cash deposits that would have offered better returns over the longer term. At the same time, firms were not doing enough to target these products to suitable customers who could sufficiently understand their risks, it said.

The FCA does not intend to introduce new rules governing these products in the short term, as its previously published guidance “provides a clear framework for firms to develop products in a way that supports the delivery of good consumer outcomes”. However, it has asked some of the investment firms and banks whose practices it reviewed as part of the project to carry out further work to determine whether their customers were affected by any of the issues identified by the regulator, including potential refunds for those who lost out as a result of firms’ failings.

“There is a place for structured deposits in the market,” said Tracey McDermott, the FCA’s director of supervision and authorisations. “But our research shows that many consumers find it difficult to understand how these work and compare them to alternatives. That is why it is crucial that firms ensure the way they design and market these products is driven by the needs of consumers. Our work indicated that this is not always the case.”

Structured products are pre-packed investment strategies based on derivatives. They operate in a similar way to fixed-rate bonds, but instead of paying a fixed rate the return is based on exposure to other assets, such as a stock exchange. As part of its research exercise, the FCA created five fictional FTSE 100-linked products and asked consumers to anticipate how they would perform over five years. It found consumers’ expectations based on the FTSE 100 were as expected, but that they overestimated the structured deposit return by an average of 10%.

The FCA also gauged consumer interest in fixed-term cash deposits for the purposes of the research. It found that consumers needed to be offered relatively high rates of return before they would choose the less risky product over a structured deposit. However, when the consumers were provided with targeted information setting out the risks of the more complex products, they became more likely to choose a fixed-term cash deposit.

The research findings reinforced the importance of firms designing structured products that were a reasonable match for the financial sophistication of consumers in the target market, the FCA said. However, some of the nine structured product manufacturers and 14 banks whose practices it reviewed as part of its work fell short of the standards set out in its 2012 guidance, particularly in relation to product design and governance, it said.

In its report, the FCA said that it was the responsibility of firms’ senior management to put customers at the “forefront” of their approach to product governance; designing products based on a clearly-defined target market identified at the start of the process. Product development and distribution should then be based around that target market. Products should have a reasonable prospect of delivering economic value to those customers, proven through “robust stress testing”; and firms should provide consumers with “clear and balanced” information on the product, its risks and potential returns, the FCA said.

Product manufacturers should take on more of a role monitoring the performance of their products throughout the life cycle, the FCA said. This should include ensuring distributors have enough information about the product to sell it appropriately, as well as following up to establish whether the product is being distributed to customers within the pre-identified target market, the FCA said.

The FCA said that it would continue to monitor the structured products market and those firms that manufacture, package or distribute the products, to ensure that firms were meeting regulatory requirements. Further regulatory action would follow if other issues came to light, it said. Over the next two years, the EU’s Packaged Retail and Insurance-Based Investment Products Regulation (PRIIPS) and recast Markets in Financial Instruments Directive (MiFID II) would also impose more detailed requirements on firms operating in the structured products market, it said.