New research from the United Kingdom’s Financial Conduct Authority (FCA) suggests that both firms and regulators need to be doing more to ensure that consumers aren’t exploited by structured products.
The FCA published a new paper today that says consumers overestimate the expected returns on structured products, such as index-linked deposits. On average, returns were overestimated significantly, by almost 10% over five years, the FCA reports. It also found that investors could not tell that structured products were unlikely to produce greater returns than fixed-term cash deposits and that consumers need to be offered relatively high returns on risk-free cash deposits for these products to be preferred to structured products.
The regulator says the research reinforces the importance of firms designing structured products that are a reasonable match for the financial sophistication of customers in the target market.
“There is a place for structured deposits in the market,” said Tracey McDermott, director of supervision and authorizations at the FCA. “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.”
The FCA also examined firms offering structured products, highlighting a number of areas of concern. The regulator says firms’ senior management must do more to put clients at the forefront of their approach to product governance; that structured products should have a reasonable prospect of delivering economic value to consumers in the target market; that firms must provide clients with clear and balanced information on each product and any risks; that manufacturers need to strengthen monitoring to ensure that dealers have enough information about their product to sell it appropriately; and that each product is distributed to its identified target market.
The regulator reports that it has asked some of the firms in the structured product sector to examine whether any of the issues identified in its research has resulted in consumer harm. And it says it will consider further regulatory action if it does not see improvements in this area of the market.
The FCA’s consumer research indicates that future work should look at determining which combinations of product features and behavioural biases drive investors’ mistakes in this area. “Product features, that can exploit behavioural biases, may lead investors to have unrealistically high expectations of product returns and impede their ability to evaluate and compare structured products,” it says.
For policymakers, the researchers say that there are several issues to consider. “First, if retail investors have limited ability to assess complex structured deposits, firms need to ask themselves whether they should be using non-advised sales channels to sell these products to retail investors,” it says. In advised channels, it says, firms “should consider how they can credibly demonstrate that advisors receive the information needed to address the effects of investor biases.”
The paper also suggests that regulators may need to require that costs be disclosed as a separate fee rather than built into the products, as investors may overlook them when estimating the realistic returns of the products. Improved disclosure, particularly better disclosure of likely product returns, the FCA adds, “could be explored as a way to mitigate the inexplicably high expectations of returns.”
The regulator cautions, however, that there are limits to how much can be solved by improving disclosure alone.