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Is bond business really a cause for complaint?

The FSA is so concerned about the potential impact of thousands of structured products maturing this year that it is has written to providers asking them to detail past sales.

Although speculation had been mounting that many index-linked bonds would fail to return investors&#39 capital at maturity, by making such an unusual request the regulator has confirmed it fears there is a real danger of yet another misselling scandal.

But if this does turn out to be the case, the “fallout” as the FSA termed it, is unlikely to resemble the pension review or any other investigation which has seen providers hit with heavy fines and reprimands. It will be advisers alone that the regulator seems set to investigate, judging by its letter which says any impact on providers will be limited as “most bonds were sold by IFAs”.

If the problem turns out to be as serious as the FSA clearly fears, the impact could be roughly on a par with split-cap investment trusts – another product which has caused some investors to lose nearly all of their capital.

As some of the earlier bonds – those sold between five and seven years ago – were routinely raising up to £130m (some far more) – the scale of the problem facing IFAs is evident.

But two questions apply. First, whether the bonds were sold inappropriately and second, whether the providers which designed and marketed some of the poorer products, such as those that had significant downward gearing, should shoulder at least part of the blame.

Simpsons of Brighton IFA partner Mark Waters says: “Providers are definitely culpable. Some of their marketing literature buried the warnings and the terms of the products. Some providers were more honourable than others in this respect. But these things were often marketed as being lower-risk products when some were linked to the Nasdaq for three years, for instance, and were very risky.”

Waters believes that any providers which marketed their bonds as guaranteeing an income of around 8 per cent could be in “big trouble” but acknowledges the issue – as with split-cap investment trusts – revolves around how clear the warnings were.

However, as the split-cap debacle has shown, no matter how bad the product, the FSA finds it difficult to investigate on the basis of past marketing literature and concentrates instead on the advice that was given. It is an argument that finds favour with a number of IFAs.

Alan Steel Asset Management consultant Alan Adam says: “I do not see how providers are culpable at all. There have been some horrendous products but it is an adviser&#39s job to weed these out for their clients.

“If their compliance records are not as they should be – and investors will complain when they lose their capital and have selective memories about what they were told when they bought the products – then they could be left facing some big problems.”

Part of the difficulty with structured products, according to Adam, is that they were an easy sell for advisers in the bull market of the late 90s. He says many investors went looking for returns of 8 or 9 per cent and he could well imagine some IFAs responding that they had just the product, while reaching for a index-linked bond brochure.

The trouble was that neither providers nor IFAs believed the markets could take the 20 or 30 per cent tumble that would negate the guarantees and cause investors to lose substantial amounts of their capital.

But it is far from certain at this stage how many of the bonds were sold on an advisory basis – something that could substantially lower the instances of potential misselling for the FSA to explore.

Chartwell director Patrick Connolly says: “Five or six years ago, nobody thought that markets would do so badly so there is an argument to say that the advice given at the time was correct. But a high percentage of bonds were sold on an execution-only basis anyway and my understanding is that the FSA is initially at least focusing on advisory sales.”

Connolly points out that a sizeable number of bonds were sold by banks such as Lloyds, which offered the products of its subsidiary Scottish Widows – a provider cited by IFAs as having offered some of the poorer products.

But again it will come down to how many of the bonds were execution-only and how many were sold on an advisory basis.

Only the FSA seems to have any idea at the moment, as providers are reluctant to divulge details which could paint them in a less than favourable light.

Scottish Mutual is thought to have a number of products which could leave investors with substantially less capital then they invested but, like some rivals, is only prepared to say it is in constant contact with the FSA about past and current products.

However, Scottish Widows asks whether the regulator really needs to look into the issue at all.

Marketing director Andy Frepp says: “There is the question whether the FSA should be pursuing this. Markets do go up and down. The products sold were almost all direct mailing and if he marketing literature makes the risks clear, then there cannot be any issue. But investors complain whether they have a right to or not.”

Even so, for the FSA to contact providers before any evidence has emerged of misselling is an ominous sign for an industry that cannot afford to have its image dented again.

Yet, if Frepp is right, the regulator&#39s swift intervention could prove to be a blessing in disguise as it will be well prepared to field complaints and quash the more spurious claims.

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