By Grant Patterson, Managing Director
In December 2013, ASIC filed a report highlighting their concern about the advice provided by 10 licensees in relation to retail structured products. Despite their concern at the time, we note since the release of that report, there have been multiple enforceable undertakings made in relation to the appropriateness of some products in relation to client investment goals and objectives. There appears to be a continued and on-going industry review of the adequacy and appropriateness of such products for clients. In some instances, ASIC has gone so far as to highlight that some advice to clients has leant in favour of such products.
The above statements also raise the question of the vertically integrated business model in financial services and the potential of a conflict of interest with relation to the provision of advice. Recent government commentary points to the desire (by government) and perhaps ultimately the intent, to see product design and distribution obligations imposed on banks.
It is fair to say that the motivation by government and the various regulatory bodies charged with protecting the retail client, are focused on the complexity of such products despite in many instances as being labelled at ‘capital protected’ or ‘capital guaranteed’.
To illustrate this point, it is worth addressing the definition of a structured product. Wikipedia defines a structured product as thus:
In structured finance, a structured product, also known as a market-linked investment, is a pre-packaged investment strategy based on derivatives, such as a single security, a basket of securities, options, indices, commodities, debt issuance and/or foreign currencies, and to a lesser extent, swaps. The variety of products just described is demonstrative of the fact that there is no single, uniform definition of a structured product.*
The risks associated with many structured products, especially those that present risks of loss of principal due to market movements, are similar to risks involved with options. The serious risks in options trading are well-established and customers must be explicitly approved for options trading. The U.S. Financial Industry Regulatory Authority (FINRA) suggests that firms “consider” whether purchasers of some or all structured products should be required to go through a similar approval process, so that only accounts approved for options trading would also be approved for some or all structured products*.
The salient point to reflect on with regards to structured products and arguably the rationale for ASIC’s findings in 2013 is that these products are highly complex and it raises the question about how such products may perform vs. owning an underlying asset and more so, their appropriateness in many instances for retail investors.
When we at Providence delve deeper into many structured products that are presented to us we generally find them quite complex and very expensive in a fee sense, which is often difficult to measure. For that reason we rarely invest in such products and prefer to either own or not own, the underlying asset. Having this independence in research is one of the advantages of not being associated with a vertically integrated product manufacturer and advisory business.
References: AFR Wednesday 18th May ‘HSBC stands to repay those given poor advice’, *Wikipedia.