Retail Product Development and Governance – Structured Product Review
Financial Services Authority
9 Stress-testing and modelling
Findings
9.1 Firms described a variety of stress-testing procedures, including quantitative modelling (some of
which incorporated ‘value for money’ tests) and ‘scenario’ assessments, which included
organisational and other qualitative risks. Tests generally were forward-looking as well as back-
testing.
9.2 It was not clear that firms’ stress tests fulfilled both the purposes of such tests, which are to model
outcomes both in the case of a product’s performing within its design parameters, and in the case
of possible failure of a design feature. For example, for a capital-at-risk structured investment
product with ‘soft’ protection
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, the former will include modelling outcomes where customers do
actually lose money i.e. the protection barrier is breached. For a structured investment product
with 100% capital protection, the latter will include modelling outcomes where the protection
fails, and customers lose money despite the protection feature.
9.3 Value-for-money tests generally involved a comparison with cash. In some cases, though, the
required additional return over cash did not seem to reflect a fair risk premium for the non-cash
product. There was evidence also of comparison with competitor products.
9.4 Stress-testing carried out in-house by some firms seemed to relate wholly to the firm’s prudential
risk management, and whether the product was a commercial proposition for the firm, rather than
to consumer outcomes. Stress-testing from the firm’s perspective is not the same as stress-testing
from the customer’s point of view.
9.5 In some cases too, stress-testing was not routinely carried out, and it was not clear how the results
of tests actually fed back into the design of the particular product being tested, or into future
products generally. In at least one firm, stress-testing was ad hoc, and it was unclear what the test
parameters were, so that it was difficult to see how it could be applied consistently.
9.6 There were varying approaches to minimum counterparty credit ratings, and there was little
evidence of other methods of assessing credit risk.
Good practice
9.7 One firm in our sample applied a quantitative cash comparator test to all structured deposit and
investment products that were entering the product design process. The purpose of the test was to
confirm that the relevant proposition was statistically likely to generate a higher return than cash.
The firm told us that any product which failed this test would then be filtered out by the firm’s
customer propositions team (through a sign-off procedure) on the basis that it represented poor
value for money and was unlikely to be a fair deal for consumers. The firm also applied a further
qualitative test to new product offerings by comparing them with fixed-term savings rates
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Soft protection is where the product is designed to repay capital only if the reference index does not fall below a
specified level or barrier.