TR15/2: Structured Products: Thematic Review of Product Development and Governance

Our recent work in the structured products market has focused on better understanding consumer behaviour and the way that firms approach product development and governance.

Structured products form an important component of the financial services industry. Products range from alternatives to cash deposits to complex investments referencing multiple financial assets or indices. This large and diverse market serves individual savers as well as sophisticated investors, corporates and financial institutions.

Since publishing Finalised Guidance on structured products in 2012, we have continued to review how this market serves retail clients. Evidence from our ongoing interactions with firms suggested further work was necessary to examine how firms in the retail and wholesale markets were developing new structured products. This report contains the findings from our discovery work in this area.

Thematic Review 15/2 [PDF][1]

Who should read this?

This report is relevant to all firms involved in any stage of the design, manufacture, packaging and distribution of structured products. Although the scope of our review did not include an assessment of sales of structured products to end customers, many of its conclusions will be relevant to firms involved in point of sale activities. Representatives of trade and consumer groups may also find its contents relevant.

Our approach

We carried out our review through three work-streams:

Research with retail customers
Supervisory work with retail firms (the ‘retail review’)
Supervisory work with wholesale firms (the ‘wholesale review’)

What were our findings?

Our consumer research highlights that retail customers generally struggle to understand the complex features common to many structured products and frequently overestimate the potential returns available from them. This can have a negative impact on the quality of their decision-making.

The reports containing the detailed findings from our behavioural and qualitative research are available below:

Occasional Paper No. 9: Two plus two makes five? Survey evidence that investors overvalue structured deposits[2]

Structured Products - Qualitative research with consumers[3]

Our discovery work with retail and wholesale firms has identified weaknesses in the way some firms approach product design and governance for structured products. Our review suggests firms’ senior management must do more to put customers at the forefront of their approach to product governance. This includes:

Identifying a clear target market during the initial product design phase and then using this information to inform each subsequent part of the product development and distribution strategy.
Ensuring structured products have a reasonable prospect of delivering economic value to customers in the target market. Firms must be able to determine and evidence this via robust stress testing as part of the product approval process. Products that fail this process should not be manufactured nor distributed.
Providing customers with clear and balanced information on each product and any risks. This is particularly important for information explaining the likelihood of potential investment returns and any risk to the customer’s capital.
Strengthening the monitoring of their products. This includes ensuring distributors have enough information about the manufacturer’s product to sell it appropriately and checking that each product is being distributed to its target market.
Applying effective product governance to ensure customers are treated fairly (including best execution where relevant) throughout the lifecycle of a structured product.

Next steps

All of the firms we assessed will be asked to explain how they will ensure the fair treatment of customers when bringing new structured products to the market. In addition, we have already asked some of the firms from our retail review to carry out further work to assess whether any of the issues identified may have affected existing products.

Within the next two years, two forthcoming EU Directives – the Packaged Retail and Insurance-based Investment Products Regulation (PRIIPS) and the recast Markets in Financial Instruments Directive (MiFID II) – will also impose more detailed requirements on firms manufacturing and distributing structured products to retail customers.

We will continue to monitor the structured product market to check whether firms are meeting our requirements. Should we identify further issues, we will consider what further regulatory action is necessary.

All regulated firms involved in the structured product market – whether manufacturing, packaging and/or distributing – should carefully consider this report, alongside our Principles, rules and guidance. Firms’ senior management should satisfy themselves that they are meeting regulatory requirements and that their approaches support the delivery of good consumer outcomes.