You probably don’t want a structured product

Structured investment products, a perennial favourite of the banks, are in the spotlight again after the FSA fined Santander for failures relating to their sales of these products.

The £1.5m fine was specifically for failing to confirm to investors under which circumstances the investment schemes would be covered by the Financial Services Compensation Scheme (FSCS).

Despite customers querying the provisions for FSCS cover in late 2008, it took Santander until January 2010 to clarify the position.

Santander sold around £2.7bn of structured products to their customers during this time.

They have been fined £1.5m for “breaching skill, care and diligence in business, as well as communication with clients”.

Reading the FSA Final Notice for Santander, several issues relating to structured investment products are apparent.

Banks love selling these products to investors with no or very low appetite for investment risk. This is probably because structured products are seen as a ‘safe’ way to participate in stock market returns without risk to capital.

In reality, the capital risk in a structured product investment is simply transferred to other forms of risk, particularly counterparty risk where the security of capital is dependent on the financial strength of the product backer.

There is no escaping the unbreakable link between risk and reward. Structured products attempt to break this link, but instead transfer capital risk to counterparty risk. If this is not clearly explained and understood by investors, there is a real danger unsuitable investments will be made.

The Final Notice also reveals what a massive cash cow these structured products can be for the banks.

If Santander received a typical 5% commission on the £2.7bn of structured products it sold to customers in this period of a little over one year, it would have generated commissions of around £135m.

Whenever we see any financial product being sold in these sorts of volumes, we are immediately concerned about its suitability for such a mass market.

Whilst FSA action like this and the impending Retail Distribution Review will both help to reduce bank reliance on the sale of structured products to customers, they do appear to remain a very popular product option for ‘advisers’ working in banks.

Most retail investors probably would not want a structured product, if they understood the risks and limitations of these schemes.

Only by speaking to an independent financial adviser with no ties to the products they are offering as solutions to financial objectives can an investor get the impartial advice they deserve.

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Photo credit: Flickr/chrisdonia