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FSA TO INCREASE INVOLVEMENT IN PRODUCT DESIGN TO AVOID MIS-SELLING

IFAonline | 26 Jan 2010 | 14.30

The FAS is to get more involved at an earlier stage of product design and stress testing, rather than just at the point of sale, to try an avoid further mis-selling scandals.

Dan Waters, director, conduct risk and asset management sector leader at the FSA, says the regulator’s work on structured products and other investment vehicles identified a “significant risk of profound mismatches between retail products produced through the investment value chain and the needs of consumers who end up owing them”.

Speaking at the McKinsey Asset Management Conference, he emphasized the FSA’s commitment to getting involved earlier in the design stage of products rather than just at point of sale.

Waters says: “We have learned the hard way that a focus primarily upon regulatory intervention at the point of sale has inescapable limitations.

“To put it bluntly, there have been too many mis-selling scandals in the UK and we want to turn the page on that part of our history.

“We want to develop a regulatory approach that looks more deeply into the value chain – into product governance, design and oversight by provider firms, rather than simply waiting to see what happens after products have reached mass circulation to the retail public.”

He also called for providers to consider gaps in consumer needs rather than focusing on who could be sold the product and how to improve marketing.

Waters says.” Often, product design seems to be driven by benchmarking against competitor products, so there is a sort of built-in circularity and re-enforcement of entrenched practices.”

He highlighted the importance of stress and scenario testing to ensure firms identify the type of customer for whom a product or service is likely to appropriate.

“This means being clear about what the product does, who it is for and certain key characteristics such as the nature and scale of risks presented.

“On stress testing, we have not seen firms adequately illustrate what they do to test products where it is appropriate to do so.

“Stress testing become important, for example where a product is geared or has pay-outs which are indicated or promised in the product’s description but which are not guaranteed. The provider should consider stress testing any product features which could lead to sharp variation in the product’s performance.”

“Stress testing should seek to identify how a product is likely to perform in potentially extreme market conditions, including, where appropriate, counterparty defaults and stressed liquidity with distributors.

“In our view, it is incumbent on providers to explore and understand their distributors’ information needs and ensure, as far as possible that distributors are getting the right messages about what particular products do and how they might reasonably be used.

“This may well include accentuating the negative, and not just latching on to the positive features of particular strategies.”

However, he says the regulators’ enhanced interest in product governance, design and oversight should not be seen as a step in the direction of increased retail product approval or design by the regulator.

He also highlighted potential concerns in areas such as the booming absolute return sector.

Waters says: “This may be especially challenging for those firms that do not have deep experience of working in the retail market, such as hedge fund managers, some of whom are getting on what is beginning to look like a UCITS III bandwagon.

“We would remind new UCITS managers that compliance with the UCITS framework will take considerable investment in systems and controls, and while asset managers may delegate various functions, they retain ultimate responsibility for compliance with the quite detailed requirements of UCITS III and, even more, under UCITS IV.”

There may be further regulatory risks as the drop in value of most asset classes has forced many investment houses to cut costs “aggressively” and there continues to be a high volume M&A.

Waters says: “Both of these developments have increased the likelihood of certain risks from a regulatory perspective; particularly those related to the retention of key staff, IT integration and ongoing management of a large number of outsourced service providers.

“It is important that firms recognise the need of retain a focus on client service and performance, and remember to treat customers fairly during periods of significant transition or integration.”

To learn more about how to successfully develop NPD strategies join our Master Class

MASTERING FINANCIAL PRODUCT INNOVATION & DEVELOPMENT
with Warren Edwardes

April 21st & 22nd, 2010
London

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Source:
http://www.ifaonline.co.uk/ifaonline/news/1588643/fsa-increase-involvement-product-design-avoid-mis-selling

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TYPES OF FINANCIAL PRODUCTS

The major types of financial products are:

Shares: These represent ownership of a company. While shares are initially issued by corporations to finance their business needs, they are subsequently bought and sold by individuals in the share market. They are associated with high risk and high returns. Returns on shares can be in the form of dividend payouts by the company or profits on the sale of shares in the stock market. Shares, stocks, equities and securities are words that are generally used interchangeably.

Bonds: These are issued by companies to finance their business operations and by governments to fund expenses like infrastructure and social programs. Bonds have a fixed interest rate, making the risk associated with them lower than that with shares. The principal or face value of bonds is recovered at the time of maturity.

Treasury Bills: These are instruments issued by the government for financing its short-term needs. They are issued at a discount to the face value. The profit earned by the investor is the difference between the face or maturity value and the price at which the Treasury Bill was issued.

Options: Options are rights to buy and sell shares. An option holder does not actually purchase shares. Instead, he purchases the rights on the shares.

Mutual Funds: These are professionally managed financial instruments that involve the diversification of investment into a number of financial products, such as shares, bonds and government securities. This helps to reduce an investor’s risk exposure, while increasing the profit potential.

Certificate of Deposit: Certificates of deposit (or CDs) are issued by banks, thrift institutions and credit unions. They usually have a fixed term and fixed interest rate.

Annuities: These are contracts between investors and insurance companies, wherein the latter makes periodic payments in exchange for financial protection in the event of an unfortunate incident.

Complex Financial Products

There are certain financial products that are highly complex in nature. Among these are:

1. Credit Default Swaps (CDS): Credit default swaps are highly leveraged contracts that are privately negotiated between two parties. These swaps insure against losses on securities in case of a default. Since the government does not regulate CDS related activities, there is no specific central reporting mechanism that determines the value of these contracts.

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2. Collateralised Debt Obligations (CDO): These are securities that are created by collateralising various similar debt obligations such as bonds and loans. CDOs can be bought and sold. The buyer gains the right to a part of the debt pool’s principal and interest income.

CDS and CDO products have played a major role in the Financial Crisis of 2008 onwards. During these troubled times, CDO ratings reflected incorrect information on the credit worthiness of borrowers, concealing the underlying risk in mortgage investments. Meanwhile, the size of the CDS market far exceeded that of the mortgage market in mid-2007. Thus, when the defaults began to unfold during the Financial Crisis, the banks were not in a position to bear the losses.

 

To learn more about how to successfully develop NPD strategies join our Master Class

MASTERING FINANCIAL PRODUCT INNOVATION & DEVELOPMENT
with Warren Edwardes

February 23rd & 24th, 2010
London

Learn more here
http://nuparc.com/divlearn/executive-training-financial-product-innovation/

Article seen:
http://www.economywatch.com/investment/financial-products.html