Nature and risk of certain types of investments and transactions

Investments put your capital at risk

• 1. Investments put your capital at risk. This includes shares and other securities, as well as products, which can offer attractive returns but put you at risk of losing some or all of your capital. You should be aware that even where an Investment is labelled as ‘capital protected’, this does not necessarily mean that the return of your initial investment is guaranteed at maturity, or when you decide to sell, as any such protection is likely to require you to hold to maturity and for certain other conditions to be met.
• Investments that put your capital at risk include but are not limited to:
  • exchange-traded Investments, including shares in companies, investment trusts, covered warrants and other products;
  • collective investment schemes, such as open-ended investment companies (OEICs) and unit trusts;
  • government and corporate bonds, as well as funds that invest in debt securities, such as corporate bond funds;
  • structured products issued by a product provider (usually a banking, insurance or investment management firm);
  • derivatives such as traded and traditional options, futures and contracts for difference; and
  • Investments linked to the performance of a stockmarket index, or some other factor such as a collection of shares or a basket of commodities, usually for a fixed number of years.

Shares

• 2. A share is an instrument representing a shareholder’s rights in a company. Shares may be issued in bearer or registered form and may be certificated or non- certificated. One share represents a fraction of a company’s share capital. Dividend payments and an increase in the value of the security are both possible, although not guaranteed. The shareholder has financial and ownership rights that are determined by law and the issuing company’s articles of association. Unless otherwise provided, transfers of bearer shares do not entail any formalities. However, transfers of registered shares are often subject to limitations. Dealing in shares may involve risks including but not limited to the following: Company risk: a share purchaser does not lend funds to the company, but becomes a co-owner of the company. He or she thus participates in its development as well as in chances for profits and losses, which makes it difficult to forecast the precise yield on such an investment. An extreme case would be if the company went bankrupt, thereby wiping out the total sums invested.
  • Price risk: share prices may undergo unforeseeable price fluctuations causing risks of loss. Price increases and decreases in the short-, medium- and long-term alternate without it being possible to determine the duration of those cycles. General market risk must be distinguished from the specific risk attached to the company itself. Both risks, jointly or in aggregate, influence share prices.
  • Dividend risk: the dividend per share mainly depends on the issuing company’s earnings and on its dividend policy. In case of low profits or losses, dividend payments may be reduced or not made at all.

Investment products

• 3. Investment trusts, unit trusts and other investment products often invest in a variety of exchange-traded Investments such as shares, debt securities, or other Investments that put your capital at risk. The value of an Investment linked directly or indirectly to the stockmarket may have a varying degree of risk, depending on its features and (if it is a product) its particular terms and conditions. The main risks involved with such Investments are:
  • the return of initial capital invested by you is not guaranteed at the end of the investment period and you may lose some or all of your initial capital invested;
  • even where an Investment is labelled as ‘capital protected’ at maturity, this does not guarantee the return of initial capital invested by you, as the level of capital protection may be contingent on the ongoing ability of the product provider or issuer to honour its contractual obligations to protect the capital of the product at maturity;
  • any losses may significantly increase if an Investment’s structure involves gearing, in which case falls in any index to which an Investment is linked can result in an even greater reduction in the capital you invested (see the clauses on geared Investments below);
  • any rate of return advertised might be achieved only after a set period and you may not know until that date how well your Investment has performed, whilst taking your money out early could result in redemption penalties and a poor return;
  • the initial capital invested may be placed into high-risk Investments; and
  • the rate of return you get may depend on specific conditions being met and even professionals may not be able to judge accurately how likely that will be.

Bonds

• 4. Bonds are negotiable debt instruments issued in bearer or registered form by a company or a government body to creditors and whose par value at issuance represents a fraction of the total amount of the debt. The duration of the debt as well as the terms and conditions of repayment are determined in advance. Unless stipulated otherwise, the bond is repaid either at the maturity date, or by means of annual payments, or at different rates determined by drawing lots. The interest payments on bonds may be either fixed or variable. The purchaser of a bond (the creditor) has a claim against the issuer (the debtor). Dealing in bonds may involve risks including but not limited to the following:
  • Insolvency risk: the issuer may become temporarily or permanently insolvent, resulting in its incapacity to repay the interest or redeem the bond. The solvency of an issuer may change due to one or more of a range of factors including the issuing company, the issuer’s economic sector and/or the political and economic status of the countries concerned. The deterioration of the issuer’s solvency will influence the price of the securities that it issues.
  • Interest rate risk: uncertainty concerning interest rate movements means that purchasers of fixed-rate securities carry the risk of a fall in the prices of the securities if interest rates rise. The longer the duration of the loan and the lower the interest rate, the higher a bond’s sensitivity to a rise in the market rates.
  • Credit risk: the value of a bond will fall in the event of a default or reduced credit rating of the issuer. Generally, the higher the relative rate of interest (that is, relative to the interest rate on a risk-free security of similar maturity and interest rate structure), the higher the perceived credit risk of the issuer.
  • Early redemption risk: the issuer of a bond may include a provision allowing early redemption of the bond if market interest rates fall. Such early redemption may result in a change to the expected yield.
  • Risks specific to bonds redeemable by drawing: bonds redeemable by drawing have a maturity that is difficult to determine, so unexpected changes in the yield on these bonds may occur.
  • Risks specific to certain types of bond: additional risks may be associated with certain types of bond, for example floating rate notes, reverse floating rate notes, zero coupon bonds, foreign currency bonds, convertible bonds, reverse convertible notes, indexed bonds and subordinated bonds. For such bonds, you are advised to make inquiries about the risks referred to in the issuance prospectus and not to purchase such securities before being certain that all risks are fully understood. In the case of subordinated bonds, you are advised to enquire about the ranking of the debenture compared to the issuer’s other debentures. Indeed, if the issuer becomes bankrupt, those bonds will only be redeemed after repayment of all higher ranked creditors and as such there is a risk that you will not be reimbursed. In the case of reverse convertible notes, there is a risk that you will not be entirely reimbursed, but will receive only an amount equivalent to the underlying securities at maturity.

Geared or Leveraged Investments

• 5.  “Gearing” sometimes also referred to as “Leverage”, means a strategy with a view to enhancing the return from or the value of an Investment without increasing the amount invested by the holders of the Investment, involving one or more of the following:
  • borrowing money;
  • investing in one or more Investments, such as (but not limited to) warrants or derivatives, for which a relatively small movement in the value or price of the underlying rights or assets to which the instrument relates results in a larger movement in the value or price of the Investment; and
  • structuring the rights of holders of an Investment so that a relatively small movement in the price or value of the underlying rights or assets results in a larger movement in the price or value of the Investment.
• 6. The strategy that the issuer of geared/leveraged Investments uses or proposes to use may result in:
  • movements in the price of the Investments being more volatile than the movements in the price of the underlying Investments;
  • the Investment being subject to sudden and large falls in value; and
  • you getting back nothing at all if there is a sufficiently large fall in value in the Investment.
• 7. Borrowing to invest allows an investor to achieve the same effects of gearing/leverage for an individual portfolio. That is to say, it increases the likelihood of sudden and large falls in the value of the Investment or portfolio, such that you may lose the value of your entire initial investment, or even be liable for further losses in the event that insufficient funds remain to repay the borrowings.

Investment trusts

• 8. An investment trust is essentially a stock-exchange listed company that holds a collective portfolio of stocks and shares, and whose performance therefore broadly reflects the performance of this “underlying” portfolio; however, as exchange-traded securities the price paid can deviate from the value of the underlying portfolio (referred to as the net asset value, or NAV), with the result that investors often buy or sell at a premium or discount to the NAV, with these discounts or premiums widening or narrowing over time. Some investment trusts are not traded frequently on the stock exchange and may be prone to illiquidity as a result, meaning that they may not always be easy to buy and sell at the price shown on screen. Although the majority of investment trusts are of unlimited life, some have a fixed or limited life, where a continuation vote needs to take place every so often and share prices can become more volatile around these corporate action events. Investment trusts are an example of Investments that may use gearing.
• An investment trust “gears up” its underlying portfolio when (to an extent that varies from one investment trust to another) it finances the purchase of securities in this portfolio by borrowing money. Nearly all trusts rely on a degree of gearing or may do so in the future. The ability of investment trusts to gear up their portfolios has traditionally been viewed as an advantage that allows them to out-perform the stockmarket.
• However, the effect can work the other way in falling markets and in the case of particularly highly geared investment trusts there is a risk of total loss of your initial investment. The effect of this gearing is that, when there is a rise in the price of the underlying securities, the value of the net assets attributable to each investment trust security rises by a greater percentage; and when the value of the underlying portfolio falls, the net assets attributable to each investment trust security fall by a greater percentage. As an alternative or additional strategy, the investment trust may pursue a policy of “cross-investing” in other investment trusts, some or all of which may themselves use, or propose to use, gearing. Accordingly, where the investment trust employs a higher degree of direct or indirect gearing, its securities are likely to be subject to fluctuations in value which are significant compared with the likely fluctuations in value of the underlying Investments. Consequently, your holding in the investment trust could be subject to sudden and large falls in value, and indeed you may get nothing back at all if there is a sufficiently large fall in value of this holding. The risk will vary from one investment trust to another.

Complex Instruments

• 9. Complex Instruments, as defined by the Rules of the FCA, include Structured UCITS, warrants, covered warrants, futures, traded options, contracts for difference, financial spreadbetting as well as other Investments from time to time, possibly including exchange-traded funds, exchange-traded commodities and structured products. Where you undertake transactions in such Investments on an unadvised basis and without adequate knowledge and experience of their operation, the complexity of such Investments increases the likelihood that you may suffer losses. It is recommended that you seek professional advice before entering into transactions in such Investments.

Warrants

• 10.  Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. A warrant is a time-limited right to subscribe for shares, debentures, loan stock or government securities and is exercisable against the original issuer of the underlying securities. A relatively small movement up or down in the price of the underlying security results in a disproportionately large movement up or down in the price of the warrant. The prices of warrants can therefore be volatile. It is essential for anyone who is considering purchasing warrants to understand that the right to subscribe which a warrant confers is invariably limited in time with the consequence that if the investor fails to exercise this right within the predetermined timescale the investment becomes worthless. You should not buy a warrant unless you are prepared to sustain a total loss of the money you have invested plus any commission or other transaction charges. Some other instruments are also called warrants but are actually options (for example, a right to acquire securities which is exercisable against someone other than the original issuer of the securities, often called a ‘covered warrant’).
• 11. An off-exchange warrant transaction involves the trading of warrants that are not listed on any exchange. These “over the counter” transactions may occur electronically or over the telephone. Such transactions may involve greater risk than dealing in exchange-traded warrants because there is no exchange market through which to liquidate your position, or to assess the value of the warrant or the exposure to risk. Bid and offer prices need not be quoted, and even where they are, they will be established by dealers in these instruments and consequently it may be difficult to establish what the fair price should be.

Securitised Derivatives (including covered warrants)

• 12. Securitised derivatives are derivative products, such as covered warrants, certificates and contracts for difference, which are freely traded and are listed on Stock Exchanges. These products will usually be classed as Complex Instruments. They enable investors to have exposure to a wide range of underlying products such as shares, indices, commodities and interest rates without investing directly in the underlying product.
• These instruments may give you a time-limited right or an absolute right to acquire or sell one or more types of Investment that is normally exercisable against someone other than the issuer of that Investment, or they may give you the rights under a contract for differences, which allow for speculation on fluctuations in the value of the property of any description or an index, such as the FTSE 100 index. In both cases, the investment or property may be referred to as the “underlying instrument”. These Investments often involve a high degree of gearing or leverage, so that a relatively small movement in the price of the underlying Investments results in a much larger movement in the price of the Investment. The price of these Investments can therefore be volatile. These Investments have a limited life, and may (unless there is some form of guaranteed return to the amount you are investing in the product) expire worthless if the underlying instrument does not perform as expected. The financial risk associated with some of these products is that an investor may lose their entire initial investment. This could occur because the product may be structured in such a way that an investor’s return depends on whether or not the underlying instrument reaches a set level or price.
• You should only buy this product if you are prepared to sustain a total loss of the money you have invested plus any commission or other transaction charges. You should consider carefully whether or not this product is suitable for you in the light of your circumstances and financial position, and if in doubt please seek professional advice.

Exchange-Traded Funds and Commodity-linked Investments

• 13. Exchange-traded commodities (“ETCs”), and other commodity-linked Investments, can sometimes underperform due to, in most (but not all) instances, being based on an underlying commodity future. This future will normally be the near month future and will thus have a finite life. At expiry the future will need to be sold and a new one bought, a process called “rolling”, and if the futures are in “contango” (the far month future being more expensive than the near month future), there will be an extra cost, which may cause the ETC (or other Investment) to underperform relative to the commodity in question. The opposite of this is “backwardation”, which would normally cancel this imbalance over time or cause slight outperformance, but it cannot be guaranteed that this will happen.
• Exchange-Traded Funds (“ETFs”) are typically open-ended investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. ETFs include Exchange-Traded Commodities, though some that invest in commodities, currencies, or commodity- or currency-based instruments may be structured differently, for example as listed debt in the form of Exchange-Traded Notes (ETNs). Unlike traditional open-ended investment companies, shares of ETFs typically trade throughout the day on a securities exchange at prices established by the market. ETFs are subject to ‘tracking error’ risks, since factors such as expenses, imperfect correlation between an ETF’s stocks and those in its underlying index, together with rebalancing of the portfolio from time to time, may cause an ETF’s return to deviate from its underlying index. Where ETFs are structured through the use of underlying derivatives, there may also be counterparty risk, in that the provider of the derivatives within the ETF may not be able to honour its commitments. ETFs have evolved over the years, becoming more complex, and investors considering ETFs should evaluate each investment closely and not assume all ETFs are alike. You are recommended to review the product literature and seek professional advice if in any doubt as to whether a specific ETF is suitable for your requirements.
• Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs (also called ‘short’ funds) seek to deliver the opposite of the performance of the index or benchmark they track. Like traditional ETFs, some leveraged and inverse ETFs track broad indices, some are sector-specific, and others are linked to commodities, currencies, or some other benchmark. Inverse ETFs may be marketed as a way for investors to profit from, or at least hedge their exposure to, downward moving markets. To accomplish their objectives, leveraged and inverse ETFs pursue a range of investment strategies through the use of swaps, futures contracts, and other derivative instruments. Most leveraged and inverse ETFs ‘reset’ daily, meaning that they are designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period, whilst the effect of daily ‘resetting’ on the performance of the ETF can be magnified during periods of market volatility.
• One of the most important factors affecting the spread is the investment or index that an Exchange-Traded Product (ETP) follows – spreads tend to be higher if these are smaller or less frequently traded. Larger, more frequently traded ETPs may have lower spreads but the spread tends to increase when markets are more volatile. The spread varies over time and is not predictable – spreads are often highest shortly after the stock market opens and shortly before it closes. Many global equity ETPs have a lower spread in mid-afternoon when the US stock market is open.

Penny shares

• 14. There is an extra risk of losing money when shares are bought in some smaller companies, including Penny Shares, as there is a big difference between the buying price and the selling price of these shares, such that if they have to be sold immediately you may get back much less than you paid for them. The price may change quickly and can go down as well as up.

Non-Readily Realisable Investments

• 15. These are Investments in which the market is limited or could become so, as there is no certainty that market makers will be prepared to deal in such Investments and adequate information for determining the current value of such Investments may be unavailable. We may recommend to you or enter into transactions on your behalf in Non-Readily Realisable Investments, or other Investments that may lack liquidity or where liquidity cannot be guaranteed, and we may deal for you in circumstances in which the relevant transaction is not regulated by the rules of any Stock Exchange or recognised investment exchange. You are requested to inform us if you do not wish us to enter into such transactions for you.

Alternative Investments

• 16. ‘Alternative Investments’ is a loosely defined term that includes a wide range of investment categories falling outside the traditional categories of Investments such as stocks or bonds. Managers of these products use investment strategies to produce returns that may be largely uncorrelated to traditional stock and bond market movements. Alternative Investments include (but are not limited to) hedge funds, real estate funds, private equity and commodity funds. When considering alternative Investments you should consider various risks including the fact that some products use gearing and other speculative investment practices that may increase the risk of investment loss, can be illiquid, may not be required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, may not be subject to the same regulatory requirements as regulated collectives, may charge high fees, and in many cases the underlying Investments are not transparent and are known only to the investment manager. Alternative investment products are not for everyone and entail risks that are different from more traditional Investments. You should obtain investment and tax advice from your advisers before deciding to invest. With respect to alternative Investments in general, you should be aware that:
  • returns from some alternative Investments can be volatile. You may lose all or a portion of your investment;
  • the use of a single manager could mean a lack of diversification and higher risk;
  • many alternative Investments are subject to substantial expenses that must be offset by trading profits and other income;
  • trading may take place on foreign exchanges that may not offer the same regulatory protection as UK Stock Exchanges; and
  • past performance of any investment is not indicative of future results.

Foreign markets and currency risk

• 17. Foreign markets, which include the financial markets of developing countries, will involve different risks from the UK markets and in some cases the risks will be greater. On request we will provide an explanation of the relevant risks and protections (if any) which will operate in any foreign markets, including the extent to which we accept liability for any default of a foreign firm through whom we deal. The potential for profit or loss from transactions on foreign markets or in foreign denominated contracts will be affected by fluctuations in foreign exchange rates.
• 18. Investments in emerging markets are exposed to additional risks, including accelerated inflation, exchange rate fluctuations, adverse repatriation laws and fiscal measures, and macroeconomic and political distress.
• 19. In relation to Investments denominated in a foreign currency, changes in the rates of exchange between currencies may cause the value or income of your Investments to go down or up, independently of their value in local currency.

Suspensions of trading

• 20. Under certain trading conditions it may be difficult or impossible to liquidate a position. This may occur, for example, at times of rapid price movement if the price rises or falls in one trading session to such an extent that under the rules of the relevant exchange trading is suspended or restricted. Placing a stop-loss order will not necessarily limit your losses to the intended amounts, because market conditions may make it impossible to execute such an order at the stipulated price.
• 21. Some open-ended funds invest in inherently illiquid assets. This means that at certain times you may experience a significant delay and/or need to accept a discount when selling an investment. The Key Information Document or the Key Investor Information Document should be read in conjunction with the fund’s prospectus for more information.

Tax

• 22. Where any publications, communications or research refers to a particular tax treatment, the tax treatment depends on your individual circumstances, as well as on the ongoing availability of the tax reliefs, and may be subject to change in future. We do not provide tax advice or accept liability for it, and you should always consider seeking professional taxation advice.
• 23. Investments should be made on the basis of the underlying investment case and should not be solely driven by tax considerations. Despite Investments such as venture capital trusts (VCTs) having the ability to diversify their portfolios, the nature of the underlying portfolios may be high risk such that the Investment itself should be treated as a high risk investment. Such Investments may require long holding periods to be eligible for the tax reliefs and for any profits to be realised. Consequently such Investments are not to be considered as short-term Investments. They may also have poor liquidity in secondary markets, meaning that it will not always be easy to sell one’s shares. You should also consider the charges that a manager of such products will levy, in particular any performance fees, as these will impact on the performance of your investment. The FCA publishes guidance on the risks of VCTs, which can be found on its website.

Securities that may be subject to stabilisation

• 24. We may from time to time recommend transactions in securities to you, or carry out such transactions on your behalf, where the price may have been influenced by measures taken to stabilise it. You should read the explanation below carefully. This is designed to help you judge whether you wish your funds to be invested at all in such securities and, if you do, whether you wish:
  • to be consulted before we carry out any such transaction on your behalf; or
  • to authorise us to carry out any such transaction on your behalf without first having to consult you.
• 25. Stabilisation enables the market price of a security to be maintained artificially during the period in which a new issue of securities is sold to the public. Stabilisation may affect not only the price of the new issue but also the price of other securities relating to it. The FCA allows stabilisation in order to help counter the fact that, when a new issue comes onto the market for the first time, the price can sometimes drop for a time before buyers are found. Stabilisation is carried out by a “stabilisation manager” (normally the firm chiefly responsible for bringing a new issue to market). As long as the stabilising manager follows a strict set of rules he is entitled to buy back securities that were previously sold to investors or allotted to institutions which have decided not to keep them. The effect of this may be to keep the price at a higher level than it would otherwise be during the period of stabilisation.
• 26. The Stabilisation Rules:
  • limit the period when a stabilising manager may stabilise a new issue:
  • fix the price at which he may stabilise (in the case of shares and warrants but not bonds); and
  • require him to disclose that he may be stabilising but not that he is actually doing so.
• 27. The fact that a new issue or related security is being stabilised should not be taken as any indication of the level of interest from investors, nor of the price at which they are prepared to buy the securities.

Margined transactions

• 28. Certain types of transaction, such as the purchase or sale of options, futures and contracts for difference, allow you to enter into contracts for future purchases, sales, or settlement of price differences, which could result in a loss of more than the amount of the initial transaction. In some cases your risk of loss may be unlimited. We will seek to notify you of the amount of margin which you may be required to provide, to help mitigate the impact of any adverse price movement, and the form in which this is to be provided. You understand that such margin may be taken to meet a loss arising on the position, and may not be recovered. The amount of margin may change from day to day, and in some cases from time to time during the day. If you enter into such transactions you agree that you will provide sufficient margin as required by us within the time and in the form stipulated by us. You further agree that, if you fail to do so, we may, without further notice, take such steps (including closing out all or part of the position) at such time and in such manner as in our absolute discretion we deem appropriate in seeking to mitigate any loss.

Money market funds

• 29. A money market fund is a type of collective investment scheme (fund) that is required to invest in low-risk securities. Money market funds typically invest in government securities, certificates of deposit, commercial paper of companies, or other highly liquid and low-risk securities. They attempt to keep their net asset values (NAV) and therefore their price constant, with only the yield (income) going up and down. These funds have relatively low risks compared to other funds and pay dividends that generally reflect short-term interest rates, but a money market fund’s NAV may fall below $1.00 or £1.00 (or equivalent) per share if the underlying Investments perform poorly, with the result that losses to your initial capital are possible. Unlike bank deposits, money market funds do not benefit from the protection provided to bank deposits by the Financial Services Compensation Scheme. Investors should also be aware that although money market funds are required to be highly liquid, offering same day or next day settlement, in certain circumstances redemptions may be suspended.

Term Deposits

• 30. Term deposits are subject to the terms and conditions of the relevant bank or building society, including as to minimum deposit amounts, interest rates and redemption periods. No withdrawals are permitted during the term; this means that a term deposit often cannot be redeemed until maturity. In exceptional circumstances where early redemption is permitted by the relevant bank or building society, this may be subject to early redemption penalties, charges and/or forfeiture of interest.

Structured UCITS

• 31. Structured UCITS are collective investment funds that use financial derivatives, usually a total return swap (TRS), to provide investors with a predefined pay-out at the end of a specific period based on the return on underlying assets. The underlying assets can consist of a variety of asset classes, strategies and indices. They are usually passively managed and can incorporate features such as capital protection or payoff guarantee.
• 32. Often the portfolio can be comprised of a TRS with a single counterparty, which provides collateral to the fund. The fund will typically invest in a portfolio of assets, such as debt securities, money market instruments and equities. The fund either passes the entire portfolio to the swap counterparty (funded swap) or undertakes to pay the return on the portfolio (unfunded swap). In return, the counterparty provides the fund with a return based on the underlying assets. There can be an increased risk to the fund of being exposed to a single counterparty, and a default of the counterparty would significantly impact on the returns of the fund.
• 33. Whilst many Structured UCITS provide exposure to a simple basket of assets or traditional index, they can also involve more complicated investment strategies which incorporate long/short equity, absolute return, complex macro, arbitrage and commodity strategies through commodity indices only. These strategies can be highly complex for a retail investor to understand, as can be the management of the TRS and counterparty collateral. There is a risk that the terms of the TRS may not allow for sufficient liquidity to meet redemption requests from investors, which could have an adverse impact on an investor’s ability to sell.

Structured products and structured deposits

• 34. Structured products are compound Financial Instruments that have the characteristic of combining a debt instrument with an embedded derivative(s) that provides economic exposure to reference assets, indices or portfolios (hereafter referred to as underlying Investments). In this form, they provide investors with pay-offs at predetermined times which are linked to the performance of the underlying Investments. At the same time, investors give up their right to any dividends that would have been received on the underlying Investments. Structured products can involve complex financial engineering. Although all structured products are slightly different they have some common features:
  • Credit risk: the holder of the product will be exposed to the credit risk of the issuer (usually a bank in the form of senior unsecured debt);
  • Capital at risk: capital repayment depends on the performance of the underlying Investments, the future performance of which cannot be guaranteed. Most structured products have some form of capital protection (often known as ‘soft protection’), which incorporates a ‘barrier’, a specified level of the value of the underlying Investments that must be breached if capital is to be lost (subject to the continued solvency of the counterparty to the derivative(s)). If this were to occur (typically at maturity only), then investors would lose capital;
  • Liquidity risk: structured products are typically only available through private placements and may not be traded on a Trading Venue. For some products, the issuer will use reasonable efforts to quote prices in all market conditions, but this cannot be guaranteed;
  • Exit risk: the availability of a secondary market price for the investment will depend on many factors including, but not limited to, the value and volatility of the underlying Investments, interest rates, dividend rates, time remaining to maturity and the creditworthiness of the issuer. There may be no secondary market at all, meaning that the product cannot be sold prior to maturity. Where it can be sold prior to maturity, the price may be less than the amount the holder would have received on maturity of the product;
  • Financial Services Compensation Scheme (FSCS) eligibility: most structured products are unlikely to be covered by the FSCS. It is important to check this. Investors’ rights under the FSCS should be explained in relevant product documentation;
  • Tax risk: the tax treatment of structured products can be complex and tax rates and regulations may change during the term of this investment. If in any doubt, investors should seek their own professional tax advice.
• 35. Structured deposits are similar to structured products but instead of combining the debt instrument with an embedded derivative, for the underlying counterparty risk they are backed with a cash deposit. In effect they resemble term deposits (such as a fixed-rate bond) with a variable return linked to the performance of an underlying reference asset or index (hereafter referred to as underlying Investments). Although all structured deposits are slightly different, they have some common features:
  • Credit risk: the holder of the Investment will be exposed to the credit risk of the issuer, subject to the underlying institution being part of the FSCS and the overall limits that apply;
  • Capital at risk: although the capital is typically guaranteed, it is only guaranteed if held to the full term and subject to the credit risk of the counterparty;
  • Performance/return: structured deposits typically offer higher returns than a fixed-rate deposit. However, unlike a fixed-rate deposit, any returns over and above your initial investment are linked to the underlying Investments. This means that if the value of the underlying Investments falls you may simply receive your initial investment and no additional return. In this scenario, once fees are taken into account you still have the ability to lose money when compared to a fixed-rate deposit;
  • Exit Risk: similar to fixed-rate deposits, the deposits should be held for the full product term. If they are sold before maturity there is chance that you will lose money;
  • Financial Services Compensation Scheme (FSCS) eligibility: unlike structured Investments, a structured deposit is usually subject to the FSCS should the underlying provider become insolvent. It is important to check this. Investors’ rights under the FSCS should be explained in relevant product documentation; and
  • Tax risk: typically structured deposits are subject to income tax, but this is subject to change.

Dilution levy/adjustment

• 36. A dilution levy or adjustment is an amount an investor pays to cover the dealing costs incurred by an investment fund when it buys or sells Investments as a result of the investor buying or selling shares/units in the fund. It is normally only charged when those costs are significant. Where a dilution adjustment is made by a fund manager, it will typically increase the dealing price for an investor when there are net inflows into the fund and decrease the dealing price when there are net outflows. The dealing price of each class of unit in a fund will be calculated separately, but in percentage terms any dilution adjustment should affect the price of units of each class identically. On the occasions when the dilution adjustment is not made, there may be an adverse impact on the total assets of the fund. As dilution is related to the inflows and outflows of money from a fund it is not possible to accurately predict whether dilution will occur at any future point in time. Consequently it is also not possible to accurately predict how frequently a fund’s manager will need to make such a dilution adjustment. Details can be found on the Key Investor Information Document (KIID) or the Key Information Document (KID). It is important to note that any dilution levy/adjustment is paid into the fund.

Key Information Documents - performance scenarios

• 37. When you buy certain types of investment products (for example, funds, exchange traded products), we are required to give you a Key Information Document (KID) drawn up by the product’s provider. In a section headed “What are the risks and what could I get in return?”, the KID presents a number of performance scenarios for the product. These scenarios illustrate the rates of return that the product might achieve in different circumstances and if held over different periods of time. However, because financial markets have experienced stronger-than-usual growth over recent years, there is a possibility that the performance scenarios – which are calculated using past performance data – may be over-optimistic. Consequently, please bear in mind that the performance scenarios are simply an estimate and that past performance is not a reliable indicator of future results.

View the Nature and risk of investments document