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Structured Products Marketing

Volume 495: debated on Tuesday 7 July 2009

I am grateful, Mr. Cummings, for the opportunity to raise this important issue; it has affected thousands of people who have lost millions of pounds in savings. I think that this is the first time that the matter has been raised properly in the House, and it provides an opportunity for a Treasury Minister to respond to the issues, although it is a mild disappointment that we have only half an hour for this debate.

In November last year, I was contacted by Peter Howard, a constituent of mine, who bought a structured savings product from NDFA financial advisers and subsequently lost all the money that he invested—£50,000—when Lehman Brothers, which it transpired had backed the product, was declared bankrupt. Structured products are a type of bond tied to the performance of other investments and sold by specialised subsidiaries based in tax havens. I do not pretend to understand the full complexity of the products—if I did, I would probably be living in a tax haven myself.

A number of issues arise out of Mr. Howard’s personal catastrophe and that of many thousands of British citizens like him. First, NDFA, and other financial advisers, had advertised the structured product as 100 per cent. capital secure. Even I, with my layman’s understanding of financial products, understand what that means and, more importantly, what it is meant to mean to those considering buying such a product. Investors were led to believe that their savings would be entirely safe. Comments such as, “100 per cent. capital secure”, “full return of capital maturity” and “capital growth without risk to your capital” are found 17 times in some plans, as opposed to one misleading, confusing and complicated risk warning found in the middle of the accompanying documentation.

Secondly, the fact that the product was backed by Lehman Brothers was hidden. When Mr. Howard bought the product, Lehman Brothers was already in trouble, and its involvement would have been a material fact that could have affected his decision to invest. Thirdly, many investors who expressed any concern about the return of capital, or asked their advisers whether there was any risk, however remote, to their capital, were told—misleadingly—that the product was covered by the Financial Services Compensation Scheme.

As I have mentioned, Mr. Howard is not alone: 6,000 British investors have lost their savings, and the total amount saved and lost is £200 million. A Mr. Moist invested £200,000 that he had made from the sale of his business. He told his Member of Parliament that he asked his adviser, Lloyds bank, what would happen if the bank went bust, and was told not to worry. Others have lost their nest eggs, redundancy payments and lump sums from their pensions. It is a personal catastrophe for many thousands of individuals. Many colleagues have constituents who have been affected, which is why a longer debate would have been preferable. Any constituent who has contacted their Member of Parliament should not be concerned by their absence today—many have been in touch with me, and we are in constant communication on the matter. They will be following up this debate. Fifty-four hon. Members have signed my early-day motion 1432 on this subject, which reveals the extent of the problem.

Indeed, this is a global phenomenon, with tens of thousands of people affected and street demonstrations in places as far afield as Hong Kong and Hamburg. I first contacted the Treasury on this matter in November 2008, and finally received a reply, on 15 April 2009, from Lord Myners, the Financial Services Secretary. Colleagues will not be surprised that the letter begins:

“I am sorry for the delay in replying”.

He then states that the

“FSA is working closely with PwC, the Lehman administrators, to gain a full understanding of the numbers of investors affected by this issue”.

The letter goes on to set out the standard procedure for investors who feel that they have been misled: to complain to the firm that sold them the product and then to the financial ombudsman—in other words, the Treasury washed its hands of the problem.

On 27 October 2008, my hon. Friend the Member for Blaby (Mr. Robathan) also wrote to the Treasury, and received a reply on 22 April 2009, again from Lord Myners, in which he elaborated and said that the Financial Services Authority was

“considering the marketing material and risk disclosures in communications issued for the products affected…The FSCS protects investors against fraud and negligence by authorised investments companies and financial advisers, but not poor investment performance”.

I slightly admire Lord Myners’ use of the phrase, “poor investment performance”. It reminds me of the “Monty Python” sketch about a dead parrot. “Poor investment performance” is an understatement when someone invests £200,000 in a product advertised as 100 per cent. capital secure and then wakes up some weeks later to find that their investment is worth precisely zero. But “poor investment performance” is the phrase that the Treasury likes to use in this case.

In a letter dated 4 December 2008, the FSA makes it clear that people who have lost their money in this way

“are not eligible to claim for compensation from the FSCS”

because their contract was with the financial adviser and not with Lehman Brothers. On 19 March 2009, the FSA indicated what it was doing to investigate the matter. NDFA, in Mr. Howard’s case, had maintained that it had been told by Lehman Brothers that it was prohibited, under EU law, from naming it as the underlying provider of the product. The FSA states that it is

“currently looking in detail at marketing literature…at the adequacy and sufficiency of the risk and product disclosure”,

although it continues to maintain that the FSCS does not cover this issue.

NDFA has tried to defend itself by attacking the investors who have lost money, saying that their campaign is an attack on the financial services industry at large, which should give us all cause for concern. Too right! As BusinessWeek reported on 6 May, Lehman Brothers Treasury sold $35 billion of dubious bonds to small investors in Europe and Asia. It reports that brokers in Asia

“plied small investors, a few of them mentally ill, with free digital cameras and flat-screen televisions”.

That is not the way that we want the financial services industry or financial advisers to behave. So this is an attack on the industry and NDFA and other cavalier advisers like them. NDFA and other advisers sold these products and they cannot simply walk away. As another adviser put it,

“we also don’t run with terms which seem too good to be true… Both Bear Stearns and Lehman Brothers pushed for business and offered fantastic terms but we declined”.

The product was inherently unsafe, devised by a greedy bank and misleadingly sold by greedy financial advisers to people for whom it was inherently unsuitable.

I am grateful to my hon. Friend for performing an enormous service in initiating this debate. He will know that many of our constituents have referred their case to the Financial Ombudsman Service, which is waiting for the outcome of the FSA widespread investigation. Can he shed any light on the time scale of the FSA investigation, which will in turn unlock the references to the FOS?

I shall put that question to the Minister when I conclude. It is important for our constituents to be aware of that investigation.

In the jurisdiction of Hong Kong, advisers who sold such products appear to have had their feet held to the fire. Hong Kong’s regulator has forced them to pay back some of the money to investors. In January, Sun Hung Kai investment services paid back £8 million to 310 investors, and only last week Bank of China Hong Kong announced that it will buy back bonds at between 60 and 80 per cent. of the original price—a total of $322 million.

As my right hon. Friend indicated, the role of the FSA has proved frustrating for many of our constituents. How could it have allowed financial advisers to market products as “100 per cent. secure” and “100 per cent. guaranteed” when there was obviously an inherent risk? Why is the FSA—and the Treasury—now hiding behind procedures that are clearly inadequate when it should be taking action? Why is it not using its power to force such advisers to come forward with proposals for compensation? How can it argue that this is an issue of investment performance and not one of negligence? Why does it pretend that the contract was effectively between Lehman Brothers and the investors when, clearly, there was a contract between our constituents and the financial advisers who sold them such products?

Will the Minister tell us why the Treasury and the FSA believe that such products are outside the scope of the FSCS, and use the opportunity to set out exactly what the FSA is doing? What is the scope of its investigation, what are its terms and when will it be completed? What does the Minister think are the possible range of outcomes of the FSA inquiry?

As I said at the start of the debate, 6,000 people have lost their life savings. They have not done anything wrong. They were not playing the markets, gambling or day trading. They were buying products, mostly at the end of their working life, which were advertised as 100 per cent. capital secure. They specifically bought those products because they wanted to keep their capital secure. They have been left high and dry, not with poor investment performance, but with losing every single penny of their investment. Those of us who contacted the Treasury on behalf of our constituents had to wait four or five months for an initial response. We now have an FSA inquiry going on behind closed doors, and nobody knows what its terms are, when it will be completed or what the possible outcomes are. This is a great opportunity for the Minister to set out in detail what is going on in this significant financial scandal.

It is a pleasure to serve under your chairmanship, Mr. Cummings. I congratulate the hon. Member for Wantage (Mr. Vaizey) on securing the debate and thank him for his constructive approach to this important subject. I am sure that it is not just his constituents who are interested in this debate, but constituents of other hon. and right hon. Members.

Structured products are essentially pre-packaged investments that use derivatives to offer investors exposure to the performance of an underlying asset or index. Typically, they offer a full or partial capital guarantee from a third party that the investor will get at least their original investment back, although inflation would mean that it was less in real terms. The majority of the investment is usually used to issue a bond, providing the capital guarantee element, while the rest is used to generate an additional return in the form of an option.

Typically, investment banks are the third-party issuers of the bonds and therefore the providers of the guarantee portion of the structured products. Following the collapse of Lehman Brothers Holdings in September 2008, the FSA identified 5,620 retail investors who had invested in structured products in which 100 per cent. of the guarantee of the return of their capital at maturity had been provided by Lehman Brothers. The investors had invested around £107 million in three products. The products were marketed by four plan managers, with 95 per cent. sold via some 800 intermediaries. The average investment was £14,500. Most products were sold during the second and third quarters of 2008 and their maturity dates are typically in 2013 and 2014.

A stable and secure banking sector in which people have confidence is essential to the function of a modern economy. This is why the Government intervened to protect depositors and maintain a stable banking system. However, as I am sure hon. Members appreciate, it is not the Government’s role to guarantee that investments always perform as well as investors hope.

The Financial Services Compensation Scheme was established by the Government under the Financial Services and Markets Act 2000 as part of a system of financial services regulation that provides consumers with statutory protection. In particular, it protects investors who have incurred financial losses arising from regulated activities under the 2000 Act when firms regulated by the FSA, including authorised investment companies and financial advisers, are unable or are likely to be unable to pay claims against them. However, the FSCS does not cover claims arising solely from investment or market performance. The FSCS assesses the eligibility of each claim presented to it on a civil liability basis, in the light of the available information and on its own merits. FSCS pays compensation only when a claimant has suffered a financial loss.

In the cases under discussion today, it has not been possible to establish a civil liability owed by the firm to retail claimants, as there was no direct relationship between Lehman Brothers and individual consumers. However, if it emerges that any of the plan managers have caused customers to suffer a financial loss and cannot meet their liabilities, the FSCS may be able to help, but only in circumstances in which the FSCS eligibility criteria are met—in particular, that a civil liability can be established.

The Government have intervened to protect depositors, such as those who held their money in the Icelandic banks. However, parallels should not be drawn between depositors and those who invested in structured products with a guarantee backed by a third party, such as Lehman Brothers. The hon. Gentleman also asked about FSCS cover for structured products. That cover will depend on the nature of the structure that is used. The absence of compensation cover may constitute a key risk and that would therefore need to be disclosed.

The hon. Gentleman asked about terms such as “guaranteed”, “protected” and “secure” in advertising material. The FSA does not have any prescriptive rules or guidance on the use of such terms, but, at all times, firms must comply with their high-level duty to ensure that promotions are fair, clear and not misleading. Firms should consider the nature of any capital guarantee or protection and ensure that any reference to them is fair and accurate. In cases in which firms have to identify explicitly a third party guarantee, the information about the guarantee must include sufficient detail about the guarantor and the guarantee to enable the retail client to make a fair assessment of the guarantee.

Under both EU and UK legislation, the FSA is responsible for the regulation of UK-based firms that provide investment products or services. As far as structured retail products are concerned, it has several responsibilities, including the regulation of firms that provide financial advice, which may be to buy such products and the assessment of the capital adequacy of firms that may provide the debt instruments that underpin structured products. It does not regulate retail structured products as a class of products as they may take many different forms and structures, each of which will have different regulatory implications under its regime.

It is not part of the FSA’s role under the 2000 Act to make comments on or assessments of the generic suitability of types of products for retail investors. However, it considers and enforces relevant disclosure and advice requirements arising from the EU prospectus directive and the markets in financial instruments directive, both of which have been fully implemented in our regulatory regime. As I said, marketing documentation provided to investors about such products must be clear, fair, and not misleading.

I hope that the hon. Gentleman will be reassured by the fact that the FSA has been actively investigating the marketing of such structured products ever since the effects of the Lehman fallout became clear. At the end of 2008, the FSA initiated a programme to review the marketing literature of the plan managers who provided such products. The review looked at whether they had complied with the financial promotion rules when marketing their structured products. In particular it considered how the market risk is described—the risk of loss of capital protection—how credit risk is described and the risk that the guarantor cannot meet his obligations. It also looked at whether the description of any guarantees was fair and balanced; whether statements about the availability of compensation cover were fair and clear; and whether the plan managers took action to alert investors following the downgrade of Lehman Brothers in 2008. That initial review has been completed, and the FSA is now assessing the most appropriate course of action to take in the light of the findings, which will probably involve visiting intermediaries and investigating the advice that was given.

The FSA’s programme of work is extensive. In addition to the review of marketing literature relating to Lehman-backed products, the work also involves reviewing the structure, risks and quality of marketing disclosure in the wider marketplace. Furthermore, the FSA has put in place a thematic project to assess the quality of advice given by a sample of the 800 financial advisers who sold the products.

In the light of the review, the Financial Ombudsman Service and the FSA jointly agreed to initiate the wider implications process, as that may have a greater chance of remedying any consumer detriment. It could also be able to deal with the concerns of more consumers’ than those who have referred cases to the FOS. I shall speak in more detail about the process in a moment.

I can assure hon. Members that the FSA is aware of the frustration of those who have made complaints and of my fellow hon. Members who have spoken on their behalf, but it is easy to see that much hangs on legal issues. Premature public statements could compromise any future FSA action on firms, or pre-empt its eventual assessment of risk in the market. However, as I have set out, the FSA is fully engaged with the issue, as it has been from the start.

As hon. Members will understand, with our highly globalised financial system, the international element is crucial, so the FSA has been working with the Committee of European Securities Regulators on a taskforce to consider how structured products are distributed and sold to retail customers across Europe. Notwithstanding that the products are written for long durations, with most maturity dates in 2013 and 2014, and that most investors would not have expected immediate access to their money even in normal circumstances, the FSA will continue to focus on addressing the matter as quickly as possible. We expect a definitive resolution well in advance of the time when most of the investors would have expected their money back.

The FOS and the FSA agreed to initiate the wider implications process on 7 May. That means that adjudications on complaints in relation to Lehman-backed structured products have been deferred to allow the FSA to investigate options for a regulatory solution that could reach a greater number of investors and address other issues arising from the sales of the products to retail customers. The process was designed to look at the implications of an issue rather than to assess the implications for individuals on a case-by-case basis. It provides a transparent means of bridging any regulatory gaps or resolving overlaps between the FSA, the FOS and the Office of Fair Trading on significant issues, particular those that could give rise to widespread consumer detriment.

The independence of the FOS and the FSA is vital in their roles of providing a safety net for consumers with complaints against financial services firms. Their credibility, authority and value to consumers would be undermined if it were possible for the Government to intervene in their decision making. The FOS will review the position following an update from the FSA on 10 August 2009.

The Government stand by the principle that investors should have access to transparent information about the risks involved in any investment, which is why we fully support the comprehensive work that is being done by the FSA and others. We certainly appreciate that such circumstances can cause a great deal of uncertainty and worry.

May I take the Minister back to the remarks she made a few moments ago? I understand her line of argument on sector-wide regulation and the regulation of a category of products, but the problem is that we have a specific example of a product that was sold to a group of customers who were mugged, frankly, by that company. We are not talking about a City-wide practice; we are talking about just one case. The Lehman-backed products were being sold in a misleading way, and it has caught out a large number of people up and down the country. They are looking for a specific solution. They are not interested in sector-wide, generic approaches; they want answers now. They have lost their life savings.

I appreciate that the hon. Gentleman’s view will be shared by the investors, but surely it is our responsibility to ensure that the FSA looks at the products. That is why, having looked at the marketing literature, its officials are going to take a sample of the advice that was given so that they can definitively say that what happened is what the hon. Gentleman says happened. It is not for me to say, which is the reason for the FSA investigation. Under the wider implications process, we may be able to help more investors, if what he says is proved.

I do not think we should trespass on the domain of the independent bodies that regulate our financial services. As I said, we expect a definitive resolution well in advance of the time when most of the investors would have expected their money back. In the meantime, we will continue to work to support the financial system to protect depositors and to secure jobs.