Ian Lowes has strong views on charges associated with Keydata structured products. Here he outlines why he believes clients continue to get a raw deal...
Keydata structured products have been among the best performing products which matured in the year.
The most impressive example, the Barclays Bank backed, FTSE 100 linked, Keydata Dynamic Growth Plan Plus 14 (Option 2) matured with a 103.5% gain at the end of its six-year term.
The fact that this was net of all adviser fees because 3% commission came out of the original investment makes it even more impressive.
Like most investments, the terms of structured products no longer include any adviser commission but they have always factored in all other administration and custody costs at the outset.
The collapse of Keydata did, however, leave an issue in terms of their own products, in that an alternative firm was required to take over administration of the products through to maturity.
Ultimately ‘full responsibility' for the management of the products was taken on by Merchant Capital in return for acquiring the client bank.
Unfortunately, the stockbroker, Pritchard Securities, that Merchant sub-contracted to do the administrative work and act as custodian turned out to be the wrong choice and when it had its regulatory permissions removed an alternative had to be found.
Reyker Securities stepped in under agreement where Merchant would meet the costs, but Reyker understandably covered themselves by way of a client agreement, which meant that if Merchant failed to meet the ongoing costs the clients would have to pick up the bill.
This turned out to be a prudent move, as ultimately Merchant's parent company collapsed taking Merchant Capital with it.
We understand that then-regulator the Financial Services Authority was involved and authorised the transfer of the administrative and custodial functions from the stockbroker to Reyker.
The Financial Services Compensation Scheme (FSCS), the fund of last resort for customers of failed authorised firms, has the stated intention of paying compensation if a firm is unable to pay claims against it.
Given that the contract that the clients originally entered into with Keydata (an authorised firm) included a clear commitment on Keydata's part to cover all administration and custody costs through to maturity and since Merchant Capital (also an authorised firm) became ‘fully responsible' for these products but also failed to meet obligations, it seemed reasonable to conclude that liability that the clients now faced as a result of the breach of contract, should ultimately fall on the scheme as those responsible for meeting the costs could not.
My firm believes that if the scheme stepped in at an early stage and accepted liability for the failed firms' breach of contract, costs could be kept to a minimum - certainly less than £1m for the estimated 11,000 clients.
'Significant sore point'
Once it became clear that Reyker intended charging clients significantly more than what Merchant were paying and what was originally built into the plans, we asked the FSCS to intervene.
Unfortunately, because Merchant needed to first be declared ‘in default' the FSCS were unable to get involved at the crucial initial stage and since then the charges Reyker have imposed have become a significant sore point.
Typically the plan management, administration and custody charges for structured products amount to less than 1% of the nominal investment amount to cover the whole investment term.
While we understand that Reyker would have been paid significantly less than 1% of the nominal investment amount for its on-going work if Merchant had not failed, they are now imposing charges on investors which are significantly more, despite only having to administer the products for the remainder of the term.
To date, this has been a matter for the Financial Ombudsman Service (FOS) who have thus far been persuaded that in the circumstances, a 1.5% charge on a small investment is not unreasonable.
However, since Reyker is imposing charges at this level on the maturity values, rather than the nominal investment amounts, in cases such as the aforementioned Dynamic Growth plan, their fees equate to more than 3% of the original investment. We have identified other cases where Reyker's fees amount to more than 5% of this amount.
While there is some argument that Reyker has had additional costs to bear arising from Merchant's demise, we do not believe that such a hike in typical fees is justified.
Regardless, it is our firm belief that the costs should not fall on the clients but instead should be met by the FSCS, as they represent a liability arising from two authorised firms, Merchant and Keydata, failing to meet their contractual obligations.
We will continue to challenge the issues via the FOS and the FSCS until we are satisfied that all angles have been explored to endeavour to get a fair and reasonable outcome for the investors.
In the meantime, lessons have been learned and one positive impact is that many providers now insist on a portion of the fees due to a third party administrator/custodian being held in a segregated client account or escrow arrangement until the eventual maturity of the investment.
This is designed to ensure that if the administrator goes out of business there are funds available to remunerate a replacement service provider.
I see no reason why such a policy should not be adopted by all providers in the interests of protecting clients and helping to continue to build confidence in the sector.
Perhaps it's time that the sector introduced something akin to a kitemark indicating that a particular provider complies with a code of conduct covering such best practices.
Ian Lowes is managing director at Lowes Financial Management
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