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Stress test to assess performance

The FSA says structured product providers should stresstest their products to establish how they would perform under a variety of conditions.

Last week, the FSA published guidance following its review of structured product development and governance.

It says stress tests should be built into the product approval process, with defined triggers for when they will be applied. The regulator says stress tests may not need to be applied in very simple repetitions of a recent product.

The FSA says stress-testing should be forward-looking as well as backward-facing and should analyse the resilience of a product over its proposed term.

It should include scenario testing of products that takes account of internal risks like failure of the firm’s systems or bigger than expected volumes, and external risks like market stresses such as interest rates changes and currency risks.

The regulator says where there is a value-for-money test, such as a comparison with cash, there should be a “sufficiently demanding hurdle rate”, or minimum rate of return.

The guidance follows an FSA review into the sector, carried out between November 2010 and May 2011, which found weaknesses in the way firms are designing and approving structured products.

Lowes Financial Management managing director Ian Lowes says: “I am not sure there is consensus on exactly what stress-testing is. I think what is key is whether products are being sold to the right sort of investors.”

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