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BSAM welcomes the FSA’s review as taking a “necessary and informed stance” in delineating between the past and pointing to the future for the sector and what is expected from providers and advisers.

BSAM believes that future must mean ‘‘the end for simplistic headline rate driven marketing of ‘easy products’ devoid of investment integrity, purpose or credibility in portfolio planning – asserting that such providers and products have no place and no future in the industry, at least not within independent professionally advised investor channels.”

However, the firm also points to the need for independent advisers to consider the specific wording of the Retail Distribution Review consultation paper, which states that advisers will need to have knowledge of structured products and how to use them, when appropriate for clients in balanced portfolio advice, if they want to call themselves independent advisers in the future.

Chief Executive at BSAM Chris Taylor said: “It is beyond doubt that the FSA has invested significant time and resource in its review of structured products, demonstrating detailed working knowledge of the industry, providers, product features and the advisory process.

‘‘The FSA output has left little doubt as to the immediate lessons for the industry, that providers and advisers must recognise and address. BSAM, however, believes this is an opportunity for the advancement of best industry practice – not least as it appears nothing less will be accepted by the regulator.’’

The FSA has focused on two specific issues relevant to ensuring investor’s interests are protected - the marketing material and approach of structured product providers and its expectations of advisers relating to the use of structured products while, also addressing wider issues in the structured products market.

The guidance to providers is crystal clear - investors and advisers must be presented with information that ensures they understand what they are investing in and any risks of doing so, specifically detailing counterparty risk, any market risk, liquidity risk and compensation scheme rules, in language that the target audience can understand. The FSA has also focused on the systems and controls that it expects firms to operate, and be able to demonstrate that they are operating, pre and post sales.

The guidance to advisers is equally clear – in respect of the standard of advice that it expects them to meet. As well as needing to understand structured products advisers must be able to demonstrate solid portfolio planning principles when advising clients, including assessing client circumstances, needs and risk tolerances, ensuring appropriate consideration of different product features and risks such that solutions are suitable, taking into account ‘basic’ portfolio planning points, such as diversification and tax.

Chris Taylor commented: “It is clearly incumbent upon the structured products industry and leading providers to advance the working knowledge of structured investments among advisers - and to ensure that the future growth of the industry is based upon client-centric, research-backed investment integrity and appropriate use of best of breed structured investment solutions.’’

Structured investments carry counterparty risk – which is a plain and simple fact – and much like equities, that can go to zero, a counterparty institution can default. The FSA’s approach in relation to providers is, however, not targeting the ‘counterparty default’, which is a ‘performance issue’ that the FSA does not regulate - rather the review has driven at the heart of the consequences of imprecise targeting of products and product literature not detailing investment and counterparty risks for investors properly, in addition to other issues such as internal processes and controls.

The review found clear failings in the quality of some advice. Some of this self evidently relates to advisers needing to understand structured products and counterparty risk adequately, and indeed many points are valid.

Some advisers may feel aggrieved that the FSA appears to be applying post Lehman knowledge to pre Lehman advice - and comment has been made about the FSA's own fact sheets pre Lehman which did not make reference to counterparty risk. However, the FSA has made it clear that it is not applying post Lehman knowledge to pre Lehman issues.

In fact, the FSA has stated clearly that pre Lehman it was reasonable to consider the use of an ‘A’ rated counterparty as low risk. It is on record stating that few people in the world would have expected Lehman Brothers to fail. It also seems clear that the FSA recognises the distinction that needs to be drawn between what could reasonably be expected from providers and advisers before the Lehman insolvency and since, in view of the specific circumstances involved.

However, post the demise of Lehman - which proved that even an investment grade bank could fail - it has drawn a line in the sand and made it very clear that due diligence considerations of counterparties must be robust, and should include factors other than just credit ratings, such as credit default swap levels and further fundamentals.

Notably, the FSA supports using credit ratings as a key indicator in assessing credit risk in the post-Lehman world, specifically suggesting that weaker rated counterparties (it specifies a ‘B’ rating as an example) may only be considered by advisers to be appropriate for investors who identify themselves as higher risk.

Generally, it should be noted that some of the advice issues detailed by the FSA, in its review of structured products, are not issues that are exclusively to do with structured products. In terms of detail, although the FSA found the advice in 73 of 157 cases, from 11 firms, to be unsuitable, this was often for reasons not specific to structured products. For instance, 67 cases related to exposing the customer to inappropriate risk, primarily placing customers who did not want any risk to capital in something other than deposits and/or not diversifying portfolios. Ten cases related to a failure with regard to tax and one case even detailed a suitability report covering an entirely different product from the one invested in. It should be remembered that all of the cases reviewed were in respect of advice relating to Lehman backed products – and in respect of this the FSA has considered and concluded that the advice was suitable in a significant percentage of the cases, further highlighting that it is not the default of a bank or the non-disclosure of its identity that was the issue (although requirements with regard to these specific points have now changed).

The fact is that some or even many of the examples of bad advice would have surfaced - and should indeed be brought to the fore - whether it had been a structured product review or a review of any type of investment or investment advice per se. The FSA found client's individual circumstances weren't properly considered, that individual risk tolerances or investment time-scales weren't taken into account; that portfolios weren't properly diversified. These failings would equally have applied if mutual funds, bond funds, hedge funds or any other type of investment product had been the focus of a review.

In this respect, at least, structured products are suffering from advisory issues that are generic and far wider financial services industry issues. But, the opportunity is now presented for the structured product industry to respond positively, and to demonstrate its value and its integrity.

Ian Lowes, of Lowes Financial Management and StructuredProductReview.com, says, ‘‘There is nothing wrong with structured products per-se and used appropriately they can be an extremely beneficial tool. When the Pensions miss-selling scandal came to light that did not mean that all pensions were bad - and when some financial advisers are exposed for failings or worse it does not mean all advisers are bad. Those who understand the market gave appropriate advice, with all the necessary warnings. As such, in our opinion, these firms provided better advice than those that avoided structured products altogether. The industry is having to learn from mistakes made but ultimately what we are witnessing is the evolution of the market and only good can come from the FSA review.’’

Peter McGahan, of Worldwide Financial Planning, added, ‘‘To my mind, for too long, too many structured products have been designed by providers who display scant regard for investment rationale or investors. Whilst I have been damning of these solutions for some time, it has been on the basis that some (too many) were ill designed and poorly understood by some financial advisers. Counterparty risk was always there - but skipped over or misunderstood. But, not all providers are the same and, as with mutual funds, there are good and bad structured product providers, even if the former is in a minority (as is the case with mutual funds). The time has come for this industry to come 'up the curve' - but the opportunity is there, on the upside, for providers who want to work closely with independent advisers, to get things right for customers. Responsible providers will embrace this opportunity, and will ensure good quality input to IFAs. Others will be forced to exit the industry. The sooner this happens the better.’’

Chris Taylor concluded: ‘‘Intelligent structured investments, founded on research backed investment thinking, that demonstrate investment integrity, that are developed in close consultation and collaboration with wealth managers and investment advisers, increase the range of investment options that can add value for investors.’’

“They are not alchemy - they do not make investment risk disappear. But, intelligent structured investments can remove, reduce or at least define market risk and change the risk/return profile of market or asset class exposure.”

‘‘Structured products’ ability to remove, reduce or at least define stockmarket risk can open up significant investment opportunities. Notably exposure to high growth investment markets and asset classes, which might otherwise be considered out of the reach of many investors, can be accessed by a far wider audience. In addition, in challenging economic conditions, when markets are generally volatile and risks and returns are difficult to control or predict, intelligent structured investments can create viable income or growth solutions for investors - when many investment options simply cannot. Therefore intelligent structured investments irrefutably have a place in a balanced and client-centric investment portfolio. It is, however, now time for the industry to stop ‘talking products’ and to think, talk and walk like an investment industry that has a role and a place in portfolio planning.’’

Whilst the past use of some structured products without adequate knowledge or understanding has now been identified, professional advisers must recognise that the appropriate response is to ensure adequate working knowledge going forward. The wording of the RDR consultation paper, produced in June, is just as clear in relation to the FSA’s proposed new standards for independent advice as the wording of the more recent review on structured products: ‘’…if a structured investment product would best meet the client’s needs and risk profile, then an independent adviser should have sufficient knowledge of these products to be able to recognise this and make a recommendation to buy this product.'’ Corporate website: Source

- FG