Breaking news on Structured Deposits: They’re still popular!
I was interested to see that Soc Gen Hambros has launched itself into the structured deposit market. Whilst, Hambros are welcome entrants to the market, there are a number of potential regulatory changes over the coming months that may be less so!
Structured Deposits are still popular!
As we approach the next chapter in the changing face of financial advice, structured deposits continue to be popular.
There are a number of reasons for this, they are:
- Simple to explain as fixed term deposits with a variable interest rate linked to the performance of a market
- Usually (depending upon the bank) covered by the £85,000 FSCS protected scheme. Of course, depositors placing larger amounts are taking credit risk
- Regulated as banking products not investments and therefore currently fall outside the scope of RDR and other such regulations
One surprising fact about the growth in Structured Deposits is that they are subject to income tax rather than capital gains tax. The former tends to be more than the latter, especially for higher earners. However, Structured Deposits can be included in tax efficient savings vehicles such as Cash ISAs albeit with a lower maxium than stocks and shares ISAs.
Increasing transparency on fees!
As the industry becomes more transparent, Soc Gen openly disclosed the maximum fees paid to the plan manager and intermediaries. Outside RDR, providers may continue to pay upfront fees to IFAs on structured deposits. However, the revenue that Soc Gen is making is not as clear. To be fair this is partly because it not always straightforward to determine the spread on a deposit unless it is being lent on the same terms to another counterpart.
What about breakage costs?
Then there is the thorny issue of breakage costs. Being a deposit, unless the bank fails, you must get all of your money back. In the UK, a non capital protected deposit is regulated as an investment for this reason.
Hence, the cost of an early breakage can sometimes come as a shock to a retail investor. With a 5 year FTSE 100 Index linked deposit, the bank uses the interest it would have paid on a traditional deposit over the term to pay fees and purchase contracts on the index. The money is put on deposit and gradually the bank earns back the interest. If a client closes out a deposit after 12 months the bank still has to earn 4 years interest before you take into account changes to the value of the FTSE 100 contract. That could lead to a high breakage cost which needs to be understood by clients upfront.
The FSA has become increasingly concerned about breakage costs for structured derivatives; will it be looking at deposits and investments too? The Skipton provides a good description of the impact of changes to a range of parameters in its brochure for the latest Super Tracker Bond including the minimum return, term to maturity, market interest rates, the performance of the linked index, commission and it mentions volatility. It is a good step forward but does not try to quantify potential costs, which is itself a challenging task because there are so many potential outcomes and none are certain.
The flip side of the coin, is that other types of investment such as mutual funds are not required to predict future bid prices. Over the next 12-18 months, the issue of breakage costs may well require some careful consideration by the industry!
Looking forward, most commentators expect MIFID II to bring structured deposits under that umbrella and to level the post RDR playing field on commissions. How will these regulatory changes affect the market? Only time will tell but Soc Gen clearly think it has a future!
Philip Bastiman is Managing Director at Structured Investment Solutions Limited. Connect with him here.