The regulator surveyed 384 retail investors who had previously bought or would consider buying structured deposits, which are often provided by high street banks as an alternative to deposit accounts.
The research was carried out by Stefan Hunt and Redis Zaliauskas of the regulator’s chief economist’s department and University of Warwick psychology professor Neil Stewart.
It found retail investors have limited ability to assess complex structured deposits and asks whether providers they should be using non-advised sales channels to sell what are often considered higher risk products to retail investors.
Where products are sold via advised channels, providers should consider how they can credibly demonstrate that advisors receive the information needed to address the effects of investor biases.
The research also suggests costs may need to be disclosed as a separate fee rather than deducted from the investment amount or built into the product design as is typically the case currently, as investors may not take them into account when estimating realistic returns.
It adds improved disclosure based on various types of targeted information, in particular likely product returns, could be explored as a way to mitigate the high expectations of returns.
The research compared investors’ expectations about FTSE 100 returns with the returns they expected from different FTSE 100-linked structured products, enabling the calculation of bias.
While investors’ expectations of the FTSE growth were on average well aligned with the assumptions used in the model, investors significantly overestimated the expected returns of all structured deposits, including many considered the most ‘simple’.
Although all structured deposits in the survey would have been unlikely to return more than fixed-term cash deposits, most investors did not recognise this and preferred the structured deposits.
The authors comments that 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.
“Innovation in retail financial markets has led to increasing product complexity over the past two decades, but there is little evidence of a comparable increase in consumers’ financial capability,” the paper states, adding that there have been numerous instances of mis-selling in recent years.
The research was conducted alongside a thematic review of structure product development and governance, which restated the principles providers should follow when designing structured products.
In particular, it says a firm should:
• identify the target market, namely which types of customer the product or service is likely to be suitable (or not suitable) for;
• ensure that the complexity of the investment proposition is a reasonable match to the level of financial sophistication and understanding of the target market;
• stress-test the product or service to identify how it might perform in a range of market environments and how the customer could be affected, and;
• have in place systems and controls to manage adequately the risks posed by product design.
In terms of providing information to distributors, a firm should ensure the information is sufficient, appropriate and comprehensible in substance and form, including considering whether it will enable distributors to understand it well enough to give suitable advice.
A thematic review of providers found deficiencies across all of the above areas, including in due diligence and monitoring of distributors, identifying needs of the target market and accurately benchmarking returns and value for money.
It has directed a number of firms to review past product sales which may result in consumer redress and has suggested if concerns are not addressed it may hand down further fines or seek more direct intervention.
peter.walker@ft.com
