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Richard Leeson: Tackling the RDR ‘grey area’ of structured deposits

Providers must treat structured deposits in the spirit of RDR

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Commission on investment products was banned under the RDR, so it was surprising to learn last week that structured deposits continue to be able to pay commission.

The FCA says structured deposits are out of the RDR’s scope because it regards them as banking rather than investment products. But is this the end of the story?

More than a few advisers will be scratching their heads at this move. The RDR sought to drive out behaviours that resulted in customers being treated unfairly, and the ban on commission was a key plank of the reforms. 

Structured deposit providers have chosen different approaches to the continued commission option. Some pay no commission, while others pay commission ranging from 0.6 per cent to 3 per cent. But if the payment of commission on investment products was seen as a possible influence towards anti-TCF outcomes, surely paying commission on structured deposits might create the same possibility.

Structured deposits, as distinct from structured products, share many of the traits of deposit accounts: fixed term, capital security, depositor protection and so on. In practice, though, it is unlikely the purchasing process is the same. Unadvised customers may be perfectly able to understand they are tying their money up in a five-year bond and sacrificing access during that period in return for 3 per cent a year interest. The same customers might struggle with how returns are described on a five-year structured deposit bond: “100 per cent of any growth (after averaging) in the FTSE 100 Index up to a maximum of 35 per gross (5.13%/ AER*) of the original investment.”

And the description of averaging makes things even more complex: “The growth of the FTSE 100 Index will be measured using the initial level of the index at close of business on a given date and the average level of the index in the last 12 months of the investment based on monthly averaging using 13 average points.” The investment element of a structured deposit product would, for most people, make it something wholly different to a deposit account – especially given the opacity of the possible return and the opacity of what the return is contingent upon.

Providers who offer commission on structured deposits, or plan to, give advisers the option to waive commission, which would be rebated to the client, who is then charged a fee. Some advisers are choosing to rebate commission for their clients’ benefit. For those that do not, there is an argument that commission bias could  exist when comparing alternatives. 

While it is right that deposit-based accounts and investments should be treated separately, structured deposits are in a grey area. For the sake of clarity and a level playing field, let us hope the market will act in the spirit of the RDR. If not, how long will it be before the FCA reviews its present stance?

Richard Leeson is director at D&W Management Consulting 

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Comments

There are 9 comments at the moment, we would love to hear your opinion too.

  1. Although I have no view as to whether commission should or shouldn’t be available on structured deposits, it’s a bit tiresome to see investors characterised as being unable to understand the returns available. Most likely investors should be able to understand English and some very simple mathematical concepts (like averaging). Commentators may not understand how banks deliver the returns available, but this doesn’t make the returns themselves complex. I’m sure most investors don’t understand why a bank charges 25% interest on a credit card and only pays 1% interst to depositors, but that doesn’t mean they can’t understand the returns they’re going to receive.

  2. It’s interesting to see how these products are structured. One industry player recently described a ‘typical’ structured deposit where 85% of the investment goes into a fixed term deposit designed to earn sufficient interest to return 100% capital at maturity; around 9% goes into a derivative to give the performance-related return; and the rest goes in fees & commission. Seems like a lot of fees & commission for something that is mostly a deposit account.

  3. A 6% charge sounds quite high these days, but even at that level (especially assuming 3% of it goes as commission to an IFA, so the effective cost is around 3% over a 5 year period) it’s a lot cheaper than pretty much any fund out there and certainly the margin is lower than the Net Interest Margin of most, if not all deposit-taking banks, so cheaper than pretty much any standard deposit.

    Whatever next, the returns on Structured Products can not only be easily understood, they’re actually good value too!

  4. MIssold Investor 28th October 2013 at 1:48 pm

    Well, if I wanted to put 85% of my investment into a five or six year fixed rate deposit account, I could do that free of charge and easily get an interest rate of 3% p.a plus compounding. With this example, the 6% costs when compared with the 9% that might go into a derivative amounts to 66%

  5. @Missold – You have the choice of putting your 85% on deposit and using the balance to purchase a derivative yourself if you want. No one is stopping you.
    It is a bit like rocket science. there are a lot of people who could build a rocket, but if someone else can build it better and more cost effectively, why build it yourself OR I trained as an Armourer in the TA and combined with some of the metalwork skills taught o other courses and at school (I went to a Technical High which became a Grammar half way through), I could produce a working gun I am sure, but it would be a lot easier either to use a 3d printer or simply BUY one on the black market. Either way it would be illegal and I’d get arrested!

  6. Commission on structured products is one of the post RDR anomalies. Not all providers pay commission – some have chosen to only offer factory gate prices on products – and in time it would not be surprising if the rest of the market moves that way.

    I second Clive’s comments re investor understanding. Contrary to the negative hype put about around structured products – they are not overly complex vehicles for investors to understand. We have been using structured products in client portfolios for many years and the premise of a product offering…

    * a defined payment outcome
    * after a set amount of time
    * in defined circumstances

    … is one they have no trouble grasping.

    The quotes from product literature in this article are taken somewhat out of context and do not reflect the clarity of structured deposit brochures currently distributed by IFAs.

    I struggle to understand how a product offering, say, “4.3 times the growth in the FTSE 100, capped at 43%” with two clearly defined dates on which this movement is observed, can be seen to be a ‘complex’ investment. Alternatively, a structured deposit may offer a fixed and clearly stated gain if the FTSE 100 is higher after five years, with capital returned if this is not the case. It is nonsensical to state that this is a complex scenario.

    No-one would suggest that structured deposits are the same as deposit accounts and for strict deposit account savers the purchase process will not be the same because there is greater risk involved and that does require greater understanding. But faced with an interest rate on a cash deposit account interest rate of 1.25% with CPI at 2.7%, utilising a simple structured deposit which can sacrifice the low interest in return for nearer 5% or more a year might make that a worthwhile exercise for some deposit capital.

    If an adviser is recommending a product based on commission that is the fault of the adviser, not the product but that’s not to say they wouldn’t have charged a non-recoverable fee otherwise.

  7. Interesting comments! Whilst the words used to descibe structured products may be easily understood, I remain unconvinced that many clients can work out what the likely returns will be. Five year return on the FTSE 100 multiplied by 35% – is this 1 &, 2% or the 5.18% cap per annum??

  8. James Harrington 6th November 2013 at 5:11 pm

    Richard. Whilst I am still slightly blushing that our coffee shop conversation led to such an extreme interest, I am certainly glad that you took the time to go away and read the brochure. The issue is however, and with your background I am most surprised, you have taken words from the brochure and given no context. Clearly that’s easier from a 28 page structured deposit KF than, let’s say an offshore bond KF.

    If your argument is that there is a dichotomy that structured deposits can pay commission post RDR, whilst investments cannot, then that’s one argument that plenty of industry participants will be prepared to debate the pros and cons of, as they do with protection products, however, to link that into suggesting it’s because these are complex products is rather lazy.

    You know the use of % within any document can be classed as confusing, however within that particular KFD from which you have quoted the payoff terms is also a table that shows the potential returns to a depositor under different scenarios, in pounds. It shows the maximum you can receive, the minimum you receive, and other examples.

    If you would like serious debate about whether these plans require advice I would love to have one. If you believe they have risks that aren’t explained, or are “too complex”, I am happy to have that one as well. However, please don’t confuse one argument with the other, or indeed any other, as they are fundamentally different.

  9. Hi James

    My concern is the commission not on a deposit but one one that links the returns to what might reasonably be called an investment. Lets have another coffee (on me ) and carry on the debate!

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