'Precipice bond' investors may not get their money back, FSA warns
15/12/2002
The Financial Services Authority is warning consumers to be careful when investing in income bonds that promise income but carry a high risk that investors may not receive back all, or any, of their original investment. These so-called "precipice bonds" are linked to derivatives such as the performance of an index or indices or baskets of stocks. They are often structured as offshore investment companies or offshore insurance companies and so are not regulated by the FSA.
The FSA issued an alert in December 1999, urging consumers to think seriously about the level of risk they were willing to accept before investing in high income products. This was followed by a consumer fact sheet in February 2000 and further alerts in March 2001, August 2001 and August 2002. The fact sheet has recently been updated and re-issued and sent to Trading Standards offices, Citizens Advice Bureaux and other advice agencies
Todays warning has been prompted by the findings of supervisory work by the regulator suggesting that the average age of investors in precipice bonds is over 60. On average, four such products are launched each month and it is feared that many retirees are buying them from a fixed amount of savings, as a way of generating income.
The FSA has analysed the performance of bonds issued before the recent market falls and is concerned that many investors will have unrealised losses that will crystallise in the next few years if markets do not recover. Around 20% of sales analysed by the FSA as part of this work were through high street financial firms, such as banks, and 12% were as a result of personal, tailored advice by independent financial advisers. However, the majority of purchasers (68%) took no face to face advice before investing.
John Tiner, FSA managing director, commented:
"We are concerned that a product which has the risk of substantial consumer loss has largely been sold through mailings and without the benefit of personal tailored advice or a face to face meeting with a qualified adviser."
"Retirees are a particularly vulnerable group as many find themselves with large lump sums to invest. They may see the word "bond" and assume that the product offers a promise that their money is safe. I urge all investors to think very carefully before making any decision and to be sure that they fully understand the risks they are taking. If current investors are concerned, they should ask their provider for a valuation before taking any action."
To alert consumers to the risks they face and the factors they should consider, the FSA's updated fact sheet on "High Income Products" highlights the risks of these bonds and the differences between these bonds and other high income products. The FSA is recommending that firms include this fact sheet when mailing customers with information about these kind of high income products and will consider whether a rule change is also necessary to make this compulsory. The regulator also expects that it will be necessary to take enforcement action in respect of some past sales.
Notes for editors
Precipice bonds are marketed under a variety of names examples include High Income Bond, Stockmarket Income Bond, Premier Bond, Extra Income & Growth Plan. They can be structured in various ways, commonly as offshore closed-end investment companies or offshore insurance contracts. As such, they are not classified by the Financial Services and Markets Act 2000 as regulated products and not covered by the listing rules that apply to UK investment companies or the UK insurance regulations. They are structured to deliver a high income without protection against loss of the initial capital invested. Return of the original capital is linked to the performance of an index/indices or a basket of stocks. Precipice bonds are typically 3 to 5-year investments although there are now some shorter-term products on the market.
FSA research suggests that some 250,000 consumers have a total of around 5 billion invested in high income bonds.
The FSA's updated fact sheet "High Income Products - make sure you understand the risks" is available on its website at http://www.fsa.gov.uk/consumer or from its consumer helpline on 0845 606 1234.
The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; the appropriate degree of protection of consumers; and fighting financial crime.
The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.