This section of the website describes how we approach complaints involving disputes about “structured products”.
A “structured product” is an investment that combines elements of investing in a bond with investing in more complicated financial instruments – often known as “options” or “derivatives”. A structured product offers income, capital growth or a combination of both, and usually has an investment term of one to ten years. Investment professionals usually consider structured products to be “complex investments”.
what are the features of a structured product?
Typically, a structured product will have the following characteristics.
Most structured products can be held in an Individual Savings Account (ISA) wrapper.
This note will focus on structured capital at risk products (SCARPs) – a type of structured product.
SCARPs generally aim to return the money invested at the end of the term if the underlying asset has not fallen below a predetermined level. But they do not guarantee to do so – hence the “capital at risk” part of the name.
They are also known as "precipice bonds". This is to reflect that, if the underlying asset performed poorly over the term of the bond, the product would "fall over the precipice" and return significantly less capital than was invested, or potentially no capital at all. The reduction in the initial capital repaid may be geared – for example, a 1% fall in the underlying asset’s value might lead to a 2% reduction in capital returned (also known as "downside gearing").
The investor may not benefit from the full extent of any growth associated with good market performance. In general the level of growth or income generated by the SCARP is set at the outset. So, if the market performs particularly well, although the consumer will receive back their initial capital and the agreed level of growth or income, their return will not reflect the full extent of the rise in the underlying asset. As a result, it may be argued that the SCARP was not suitable for a consumer with a higher risk profile. However, when we look into these cases, we will always take into account the particular circumstances involved.
Most SCARPs must be held for the full term of the investment. But an early redemption plan (or "kick-out" plan) can mature earlier than the full term (usually on any anniversary of the plan start date) if certain criteria are met.
We usually find that consumers have invested in a SCARP on the advice of an independent financial adviser (IFA). Although we occasionally see that they have responded to a mailshot offer directly from a product provider.
Although a SCARP might involve an offshore company, we will usually still be able to consider the complaint, as long as the financial business concerned is regulated by the FCA.
Non-regulated guaranteed bonds (also known as guaranteed equity bonds or guaranteed capital bonds), are not the same as SCARPs.
Non-regulated guaranteed bonds have some similarities to SCARPs because their returns are linked to the performance of a stock market index or certain other assets over a specified period of time.
But there are key differences between non-regulated guaranteed bonds and SCARPs:
Because of the features involved – and the fact that they are essentially deposit accounts – complaints involving non-regulated guaranteed bonds will generally be considered by our banking area. However, that will largely depend on whether a consumer was given advice to invest in the guaranteed bond. If they were, and the complaint is about that advice, it is likely that the complaint will be considered by our investment area.
The complaints we see usually involve
Most SCARPs contain an element of risk. The risk is that the full capital the consumer has invested will not be returned to them at the end of the product term. This could be because of a counterparty failure, or because the underlying asset’s value falls below a certain level.
We generally consider SCARPs to be unsuitable for investors who do not want to take any risk with their capital, or for investors who are not in a position to sustain a financial loss.
Most of the things we take into account are the same as in any investment complaint, including:
More detail about how we assess the suitability of investments can be found in our online technical resource.
We used to see complaints about ”conventional” SCARPs from consumers who had lost capital, and who said they were not aware of the risk to their capital, or how much it would be affected by gearing when they entered the plan.
However, we now see fewer of these complaints, which suggests that consumers are being made more aware of the risks involved.
Now we tend to see more complaints about a different type of SCARP – which carries a degree of security that the capital will be returned. The ”guarantee” is based on the capital protection element issued by the counterparty (referred to earlier in the note).
The capital invested in the SCARP will be returned to the consumer at maturity, as long as the counterparty is able to honour the agreement to pay out on the "IOU". If the counterparty goes into liquidation, it is unlikely to be able to honour the agreement and the consumer is at risk of losing some or all of their original investment. Consumers have referred complaints to us where the counterparty was a bank which has now gone into liquidation – for example, Lehman Brothers.
Following the collapse of Lehman Brothers in September 2008, SCARPs with Lehman Brothers as the counterparty were unable to repay capital to investors. In October 2009, the financial services regulator at the time, the Financial Services Authority (FSA) published reports on both the collapse of Lehman-backed SCARPs, and more generally on what it expected advisers and product providers to explain about counterparty risk at the point of sale. For more information on this please see the additional resources section below – which also includes a more recent FSA review of structured products.
In the reports, the FSA said:
A firm’s communications with customers – including its suitability reports – should communicate the risks of investing in structured investment products in a way that is fair, clear and not misleading, including setting out any possible disadvantages for the customer. This includes, but is not limited to, explaining to the customer the nature of counterparty risk and the possibility that, if a counterparty failed, their capital could be lost.
We sometimes see complaints from investors that the risk of counterparty insolvency was not made clear to them – or even that the existence of a counterparty was not explained to them.
Where a complaint like this is made against an adviser, we will consider whether the adviser explained the counterparty’s role at all, and if so, how they did it.
For a complaint directly against the product provider, we will assess how the product brochures described counterparty risk. We will consider whether
In its October 2009 reports on structured investment products, the FSA stated that for all sales:
we consider that advisers should have had regard to the financial strength of the underlying counterparties and whether this was appropriate given the customer’s attitude to risk.
But it distinguishes between the duties of an adviser before Lehman’s insolvency in September 2008, and their duties after that date:
“However, we consider the due diligence it was reasonable for advisers to apply on the financial strength of the counterparty changed after Lehman’s collapse:
1. We have not applied the benefit of hindsight to the period before Lehman’s insolvency (in September 2008). Where a customer was willing to take counterparty risk we believe that it was not reasonable to expect advisers to distinguish between the financial strength of different counterparties that were rated A or above in this period.
2. However, from September 2008, given the failure of an investment grade counterparty, we expect advisers to have undertaken a higher degree of due diligence when recommending products with counterparty risk, and to consider more carefully how this may relate to each customer’s attitude to risk.
This due diligence includes: consideration of the number of counterparties underlying a single structured investment product; the location of the counterparties (eg UK-based, offshore, US etc); and the relative financial strength of counterparties.”
The regulator points out that counterparties with stronger credit and financial indicators might be more appropriate for consumers looking for a lower-risk investment, while less strong counterparties could be more appropriate for consumers looking for a higher-risk investment.
It goes on to explain what a product provider should state in its financial promotion literature about counterparties:
“Financial promotions for structured investment products must:
The regulator has stated that terms that imply security should only be used where they are accurate descriptions of the risk to capital within the product. Examples of these types of words are secure/safe/protected/guaranteed. The regulator says that literature needs to be clear, fair and not misleading, and that it expects
“promotions to name the counterparty in order to be able to describe the counterparty risk fairly. So, it would not be sufficient to simply state that the counterparty is a ‘major financial institution’. In addition, any description of the counterparty must be fair, clear and not misleading.”
The regulator distinguishes between sales that took place before and after September 2008 for due diligence purposes. We will look at each case individually and make an assessment based on its own individual circumstances.
We may also need to take the following factors into account when we investigate a complaint about SCARPs:
If we decide that the SCARP was not suitable for a consumer, we will need to consider carefully what the consumer would have done if they had not invested in the SCARP. The starting point is to put the consumer in the position they would have been in if they had not received unsuitable advice.
Calculating compensation is done in two stages:
Stage 1 – alternative return
If we are satisfied that a consumer would have invested in a different scheme, and we know what that that scheme would have been, we can calculate what the return would have been.
If we are satisfied the consumer would have invested elsewhere for the opportunity of a reasonable return, but we cannot be sure where they would have invested, we are likely to use a fair benchmark to calculate an award. This may be based on a return linked to the Bank of England (BOE) base rate (traditionally BOE +1%). However, a lot will depend on the individual circumstances involved – and we might tell the business to pay compensation based on a different approach.
If we conclude that the consumer would have left their money in a deposit account, we will apply a reasonable rate of interest to the capital amount – which in some instances will be reflected by the Bank of England base rate. But again, some circumstances may require us to take a different approach.
Stage 2 – reduction in value
Once we have calculated the amount of alternative return that the consumer would have received, we need to deduct the benefit that the consumer has already received from the SCARP. This will be the maturity/surrender value of the SCARP, along with any withdrawals that have been made.
We might see a situation where the SCARP has no value at all – for example, if the counterparty is in liquidation.
We will often consider whether an award for distress and inconvenience is appropriate. This could happen where, for example, an elderly consumer has taken out a SCARP to increase their retirement income, and something has gone wrong with the SCARP.
We may also make an award if a financial business has handled a consumer’s complaint poorly. You can find more information about our approach to awarding compensation for distress, inconvenience and other non-financial loss in our online technical resource.
ISA allowances – our approach to compensation where a consumer misses their annual ISA allowance because of a business error.
Structured Product Review – Carried out by FSA and published March 2012.
Treating customers fairly – structure investment products – published by the FSA in October 2009.
Quality of advice on structured investment products – findings of a review of advice given to consumer to invest in structured investment products backed by Lehman Brothers from November 2007 to August 2008. Published by the FSA in October 2009.
contact our technical advice desk on 020 7964 1400
This is part of our online technical resource which sets out our general approach to complaints about a wide range of financial products and issues. We would like your feedback on how helpful you found it. Please also use the feedback form below to tell us about anything you think we could clarify or explain better.