Structured Products and Structured Deposits and the cost of Transactions and/or Advice
STRUCTURED PRODUCTS are “Contract Based” investment solutions which mean that the investment parameters are defined at outset and are generally linked to an investment index – where the return results are correspondingly dependent on the results of the underlying investment index. Generally, the greater the “contract return” the greater the risk taken with the capital and potentially the income derived from the Structured Product.
You may be familiar with the term SCARP – which describes a ‘Structured Capital at Risk Product’. A description of the terms may help your understanding.
The FCA define a structured capital-at-risk product (SCARP) as a product other than a derivative, which provides an agreed level of income or growth over a specified investment period and displays the following characteristics:
- the customer is exposed to a range of outcomes in respect of the return of the initial capital invested;
- the return of initial capital invested at the end of the investment period is linked by a pre-set formula to the performance of an index, a combination of indices, a ‘basket’ of selected stocks (typically from an index or indices), or other factor or combination of factors; and
- if the performance in (b) is within specified limits, repayment of initial capital invested occurs but if not, the customer could lose some or all of the initial capital invested.
A non-SCARP structured investment product is one that promises to provide a minimum return of 100% of the initial capital invested, so long as the issuer(s) of the financial instrument(s) underlying the product remain(s) solvent. This repayment of initial capital is not affected by the market risk factors in (b) above.
(The following explanation is directly from the FCA……). They state;
“We define a structured deposit as in the FCA’s Handbook i.e. as a deposit paid on terms under which any interest or premium will be paid, or is at risk, according to a formula which involves the performance of:
- an index (or combination of indices) (other than money market indices); or
- a stock (or combination of stocks); or
- a commodity (or combination of commodities).”
Structured (Investment) Products generally are exposed to “Capital at risk” – so the buyer of a Structured Product must be aware that the “contract risk” they are buying into, corresponds with their risk objectives.
We provide the full details on our website of all of the product solutions that we market on a non-advised basis including Key Information Documents (KIDs). We offer a number of SCARP – Structured Products on our website – although it is clearly explained and confirmed that no regulatory protection (via the Financial Ombudsman Service FOS) is provided to a buyer of a financial product, where the process of advice isn’t entered into. This is known as the “know your customer process”, which requires the gathering of a Personal Financial overview – or fact find, along with a Risk profiler, which enables a “suitable outcome” to be concluded, following discussion and consideration with the consumer. Importantly, all cost disclosures must be clear and transparent to consumers also – both on an ‘advised’ and ‘non-advised’ basis.
There are a number of Providers who will only allow a product to be consumed having taken financial advice; following the regulatory process, so it is important that consumers of financial products know the difference in relation to the benefit of regulatory protection and where the consumer of non-advised products have no ‘advice’ regulatory protection. The difference in relation to the ‘cost of advice’ is also essential to understand. Advice requires the process of ‘Know Your Customer’, Risk Profiling and a suitability letter/report to be concluded, where the qualified adviser has to pay regulatory fees in order to be able to provide advice, pay professional indemnity insurance in case of a failure of advice (this is compulsory regardless of history); all of which costs money and takes time. Advice costs are therefore greater in time and cost demand than non-advised transactions and provide the consumer of financial products with much greater protection.
The Retail Distribution Review classified the need for transparency of cost and services. It should be clear that “advice” or “guidance” is not provided to purchasers of products who buy on a NON-ADVISED basis (or sometimes referred to as execution only basis – which, in my view, is an incorrect term).
Costs for Transactions
There are a number of transactional, NON-ADVISED distributors who are charging 3% for a NON-ADVISED business model transaction. We (Best Price FS) charge 0.3% with a minimum fee of £50 per transaction, 10 x less than a number of distributors on a Non-Advised basis. (We are currently reviewing our transaction costs, which is likely to increase to 0.5% and £75 per transaction – but this remains extremely good value, especially related to other business models within the Structured Product space). The regulator is keen to increase pricing competition in the ‘advised space’ – so where a consumer purchases a product without taking advice, therefore has no regulatory protection it is certainly of benefit to save money on transaction costs, searching for the best price Non-Advised transaction cost will clearly benefit the purchaser of a financial product – if no advice is required. Best Price FS currently charge 3% for full advice that provides regulatory protection for the consumer, so it is important that the message of value and choice is explained to consumers.
Charges eat into returns – fact. Investment advice is, in our view, essential but it’s clear that there is a growing number of DIY investors in the Structured Products space, as the contract Key Information Document explains the main contract parameters so ongoing management and rebalancing is not required by an adviser, in line with an investors’ objectives. ‘Contract based’ investment solutions therefore enable more consumers to buy without taking advice, as the contract terms are clear at outset. Of course, the consumer should study and understand the strengths and weaknesses of the product proposition prior to purchase, such as the relative strength of the counterparty.
What is crazy in my view, is where consumers pay “advice like” costs for ‘NO ADVICE’ and do not benefit from regulatory protection, which is why we looked to develop our business model post the Retail Distribution Review (RDR), so to create the ‘Best Price’ for consumers to buy relatively easy to understand products without taking advice.
Structured Deposit Transaction Costs
What is furthermore evident is where ‘Structured Deposit’ Consumers purchase a Structured Deposit Product paying “ADVICE like” costs at 3%. The likely returns are lower than SCARP solutions, so costs eat further into returns. The business models of large scale distributors are very successful at maintaining their model, as they have a captive audience, where due to solid investment returns the solutions have delivered to expectation in years following the credit crisis in the main, so investors often re-invest the capital with the same distributor, regardless of the cost to purchase the product.
A Structured Deposit by the very nature of the ‘Deposit Structure’ has a lower return, so the cost to purchase clearly becomes an increasingly important factor.