Whatever potential issues there are with structured products, one of the most common criticisms levelled at them is their complexity.
There is a whole host of possible issues with structured products, including the question of whether or not they are appropriate for particular clients and in what quantities they should be bought. It is by no means true that structured products present no risk to the consumer, but it is still worth asking whether they really are as complex as their reputation would suggest.
Their objective is to meet very customised risk-return objectives. They take a traditional security, which could be a bond, and instead of usual payment features such as periodic coupons, they replace them with payments that come from the performance of an underlying asset.
Structured products are a fixed-term investment made with a lump sum, linked to an underlying market or asset that provides pre-defined levels of growth. It is the issuer of the bond that is responsible for delivering upon maturity, and the counterparties contractually define what they will deliver. The variety of outcomes are not determined by active management, and is wholly established when the product is purchased at the outset.
Upon maturity (in essence, when the fixed term comes to an end), in a capital-protected plan the aim is to return the initially invested capital at the very least. If it is not a capital-protected plan, there is the possibility of losing some or all of the capital if the index the plan is linked to falls below the limit agreed when the plan was taken out. The main problem arises if the counterparty that provides the capital protection fails during the term, which is when the potential to lose all the initial investment arises.
The Financial Services Compensation Scheme does not cover all issues that arise from the failure of a counterparty.
