Financial industry's 'risk' problem

Poorly performing markets have led to complex products falling in value

The city regulator has admitted to problems over the financial industry's understanding of product risk and a "degree of complacency" over stock market performance, following a string of recent mis-selling scandals.

Millions of people were sold products such as endowments, split-capital investment trusts, and high-income bonds believing them to be a low-risk way of benefiting from rising share prices.

But poorly performing markets have led to the often complex products failing, leaving thousands of investors out of pocket.

Mary Hollinshed of the Financial Services Authority (FSA) said there have been issues over the industry's "own understanding of risk", but was adamant they were working hard to improve it.

Speaking to BBC Radio 4's Inside Money programme she said there was no doubt consumers did not understand the risks they were taking on, and said of the industry:

"They have all had a very nasty fright over recent years and are thinking much more carefully about the products they design and how they could work in adverse circumstances."

Hefty penalty

Pip Flegel is one of thousands of people who invested in with-profits bonds.

INSIDE MONEY, BBC RADIO 4 Saturday, 14 August, at 1204 BST Repeated on Monday, 16 August, 2004 at 1502 BST Programme information

Because of the way these products are structured, they are subject to stock market fluctuations, and three years of falling share prices have had a damaging effect.

Disappointed with her bonds performance, Ms Flegel is also angry that in order to withdraw her money or move it elsewhere, she must now pay a hefty penalty.

Speaking to the programme, she said: "The way I feel at the moment, keeping it under the mattress would have been a better option."

When she read the small print about the complicated product she was being offered, she said: "it did not mean anything to me, it sort of went over my head".

Poor communication

We need to educate the consumer that many of the products they invest their capital in carry a degree of risk Nick Bamford, Chairman of the Society of Financial Advisers

Independent financial advisor Ian Head believes complicated products need to be better explained to people.

"Unfortunately, the industry has been very poor at communicating in terms that we can understand."

Nick Bamford, Chairman of the Society of Financial Advisers, agrees - saying the FSA bears some of that responsibility:

"I think a regulator has a role to play in terms of making sure that there are robust definitions of product risk.

"We need to educate the consumer that many of the products they invest their capital in carry a degree of risk.

"And I think there is a responsibility on the part of the adviser to be well-educated and qualified and to be able to explain really what risk is."

Risk perception

The FSA is now looking at ways of making risk levels simpler.

Mary Hollinshed said: "Part of the problem is that the financial services industry gets so used to using jargon they stop thinking about it from the perspective of the consumer."

While some financial companies describe certain products they sell as low risk, other firms would define them as being low to medium risk.

Challenged over a need for standardisation across the industry, Mary Hollinshed told Inside Money:

"We've certainly said that we're going to work with the industry to find out whether that's feasible. But I don't want to hide the fact that it's an extremely complex area and that risk doesn't arise from one particular source."

Pressure for change

But pressure to develop some form of risk indicator for consumers has been mounting.

In a recent report on restoring confidence in long-term savings, the House of Commons Treasury Select Committee said: "Too often... savers have bought long-term savings products without any satisfactory explanation of the inherent risks...

"The industry should appreciate that, if such an indicator is implemented, it would provide an important safeguard against mis-selling."

BBC Radio 4's Inside Money was broadcast on Saturday, 14 August, at 1204 BST.

A slightly longer version of the programme was broadcast on Monday, 16 August, 2004 at 1502 BST.