How to Ensure Structured Product Suitability

Back in the dark days of 2008/09, the market for structured products was put under the microscope of the then FSA after the collapse of Lehman Brothers left some investors high and dry.

The findings of the FSA review into the suitability of advice on these structured products (Structured Products: Thematic Review of Product Development and Governance) found three main failings: a failure to consider the suitability of the products from a risk perspective, an over-concentration of clients’ assets into structured products and a failure to consider the tax position of the client.

In 2016 it is easy to look back and say that these failings are not unique to structured products; indeed, there is nothing inherent in structured products that led to these failings. Rather, a lack of coherent investment philosophy and process, coupled with a culture of intermediating product as opposed to offering a genuine advice service led to these failings, and they will apply to many other investment products.

One could argue that the key to correct due diligence and research of the market for structured products is no different from any other investment solution; it is about having the right funnel. If you start with the whole of the relevant market you can filter down by asking some broad-based “enhanced suitability” questions.

For example, does the client need access to their money in an emergency? If so, then all fixed- term products can be discounted and only easily liquidated assets should be used. Does the client require FSCS cover on all their assets? This means structured capital at risk products that are classed as a loan to the investment bank can be discounted, but structured deposits should be assessed. A good investment advice process should have a series of these broad enhanced suitability questions in order to filter the wider market down.

At this point, it is crucial to be able to assess both risk and capacity for loss and apply the findings of this process to investment selection. There must be a logical link between the investment selected for the client and the agreed risk profile and documented capacity for loss. It is noteworthy that many firms are still getting this wrong, as the FCA review of suitability in wealth management firms has found (Wealth management firms and private banks: suitability of investment portfolios). When assessing structured products against the risk profile and capacity for loss of the client, there are many considerations. Once simple mnemonic I have seen firms apply is CLEAR:

• Counterparty – who is making what promises and how likely they are to keep them?

• Length – is the term appropriate for the client’s planning needs and tax circumstances?

• Exposure – what is the client actually exposed to and does this meet their capacity for loss?

• Access – where can the product be held (for example, Isa, Sipp) and is this appropriate?

• Risk – does it match the client’s profile?

Naturally, the more complex the type of product, the more difficult it is to apply these screening criteria. The more design features manufacturers build, the more onerous the process for advisers. This is why structured deposits, where the capital is only exposed to counterparty risk rather than any market risk, are often more readily incorporated into the advice process. One simple rule of thumb can therefore be, if it is too complicated to explain to a client, don’t use it.

Of course, a strong advice process needs to be backed by competent advisers and there is no substitute for structured CPD. This is one of the reasons why when we launched our structured deposit last year we decided to only allow advisers who have undertaken our CPD education to have a unique agency number – demonstrating that they understand the above process, and protecting both advisers and their clients from unsuitable advice. - fundstrategy