Could Structured Products Be Banned?

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Could Structured Products Be Banned? That is exactly what Japan is contemplating.

According to a recent Bloomberg article, Japan is cracking down on its $29 billion structured products market after retail investors suffered significant losses. The country’s financial regulator wants to largely eliminate the sale of structured notes to retail investors, which offer higher returns than regular debt but at significantly higher risk.

Banks such as UBS (UBS), Merrill Lynch and Morgan Stanley (MS) sold over $ 100 billion in structured notes in 2021 to their fixed income customers who were seeking higher yields as bond and CD yields were at record lows. 

The pitch to investors was that the notes were like higher paying bonds which would generate outsized returns linked to the performance of equity indices or stocks like Apple or Tesla.

Structured notes, however, are vastly different from regular bonds. Although they are technically debt obligations with a maturity date, say one or two years, neither the coupon payment nor the full return of principal is guaranteed.

Many structured note investors may not be aware of the limited principal protection of their notes. When the note’s reference index or stock falls below a certain level, such as 20 or 30 % , the note will suffer large principal losses. The recent market declines will result in commensurate large losses in market linked structured notes.

Another risk of structured notes is that there is no liquidity. There is no active secondary market where a note can be sold before maturity.

Many investors were not told of these risks when the notes were sold. In fact, as with many complex products, many brokers did not understand these risks or communicate them to their customers.

Investors may be shocked to see large principal losses on their structured notes as equity markets fall. Buyers of structured notes are going to end up taking losses that they agreed to but didn’t expect would actually happen.

U.S. securities regulators have levied substantial fines on banks such as UBS and Merrill Lynch for structured note abuses and issued risk disclosure guidelines. The regulators should consider whether to ban the sale of these complex products to retail investors who are being harmed.

Investors who believe they were sold structured notes by brokers who did not disclose the risk of significant losses can bring a claim for investment fraud in a FINRA arbitration case to recover their losses.

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Disclaimer:This article does not contain investment, tax or legal advice.

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