If Justin Beeton and his miserable Berkshire Hathaway-style products were in Belgium, he would have every right to be very nervous about now.
Beeton's Sydney firm JB Global was out there not so long ago selling what was termed "the ultimate Warren Buffett investment".
You might think the ultimate Warren Buffett investment would be an investment in Buffett's famed investment vehicle Berkshire Hathaway. Indeed, JB Global and its marketing seemed to invite the perception that was exactly what you would get if you invested in JB Global's "Berkshire Hathaway Income and Equity Accelerator".
The website had the gall to include six video grabs from Warren Buffett, courting the inference that the Sage of Omaha was endorsing JB Global's product.
Marketing material stated: "You can invest in Berkshire Hathaway without any of the usual risks."
At the time, Beeton defended the advertising campaign, saying: "We are investing in Warren Buffett that's what we are doing.'
A look under the bonnet of JB Global's product showed it was anything other than a straightforward investment in Berkshire Hathaway shares. In common with many of JB Global's products - often "manufactured" by large investment banks such as RBS - the Berkshire Hathaway product was a complex melange of loans and derivatives.
As a sign of the complexity, the Berkshire Hathaway product allowed you to claim tax deductions on the interest of a "loan" to buy the investment. Remarkably, you weren't actually liable to pay the loan back - hence my description of it as a "loan".
JB Global is not the only one offering these kinds of complex structured products. For example, Macquarie Bank has been out there with its Flexi 100 products offering similar features.
Amazingly, Macquarie won an Australian Tax Office ruling supporting the tax deductibility of interest on what I see as a nonsense loan.
In keeping with many of these complex products - and increasing their attractiveness to retail investors - there is often some form of capital guarantee.
Such "guarantees" are also a sign of the product's complexity - the guarantees are tightly limited and defined in the fine print of 100-odd page product disclosure statements.
JB Global is no longer selling a product tied to Berkshire Hathaway shares. However, it now offers JB Global Superannuation as its "flagship service", offering the ability to invest your super in its range of complex structured products.
But I digress. Why would Beeton be nervous were he doing business in Belgium? Rather sensibly, the Belgian regulators have decided to impose a moratorium on complex structured products being sold to retail investors.
I say rather sensibly because the Belgians seem to have developed an alarming love affair with these kinds of products, investing ?85 billion in them when they have a total of only ?200 billion invested in shares.
The moratorium was agreed to by the product manufacturers ahead of Belgium's Financial Services and Markets Authority introducing tougher regulations governing the area. To determine whether a
structured product fits the definition to be covered by the moratorium, the Belgians came up with a four-step process.
I'm pretty confident most of JB Global's products would have been nominated as complex after step one, which asks whether disclosure of the underlying value of the product is accessible.
But even if JB Global's products somehow scraped through step one, they would almost certainly be judged to be complex in the next three steps:
Is the strategy overly complex?
Is there an overly complex calculation formula?
Is there transparency regarding costs, credit risk and market value?
In the case of JB Global's labyrinthine product disclosures, the answers are yes, yes and no.
The Belgians' proactive steps to head off what they manifestly see as a looming problem - heavy retail losses and immense value leakage to investment banks - is being mirrored by regulators globally.
Chastened by the global financial crisis, regulators are moving to address the potential impact of financial products on retail consumers.
In a discussion paper titled "Product Intervention", the UK Financial Services Authority chairman, Lord Adair Turner, stated: "[The paper] proposes a quite new and more intrusive approach to the regulation of retail financial services, aiming to ensure that potential consumer detriment problems are identified and offset at an early stage."
Similar moves are also afoot in Australia. In its submission to the federal parliamentary inquiry into the collapse of Trio Capital, the Australian Securities and Investments Commission flags its own awareness of the need to go beyond traditional regulation of retail products.
Also, through his role with the International Organisation of Securities Commissions, the chairman of ASIC, Greg Medcraft, has been following the Belgian experiment with interest and a degree of admiration.
And JB Global has not escaped attention either. In July, ASIC imposed licence conditions on JB Global after finding "cases of inappropriate advice, failure to adequately investigate clients' situations and inadequate consideration of the characteristics and risks of the structured products".
It also found (surprise, surprise) some of JB Global's marketing material "may have been misleading, by accentuating the potential benefits of the investment without balancing those benefits against the risks".
Perhaps Justin Beeton, and other floggers of complex structured products to retail investors, should be nervous in Australia as well.
Frequently Asked Questions about this Article…
What are complex structured products and why should everyday investors be cautious?
Complex structured products are investment packages that blend loans, derivatives and other features rather than simply buying shares. The article highlights they can be hard to value, have complicated calculation formulas, limited and tightly worded ‘capital guarantees’ in long product disclosure statements, and can expose retail investors to hidden costs, credit risk and value leakage to investment banks.
What was JB Global’s “Berkshire Hathaway Income and Equity Accelerator” and why was it controversial?
JB Global marketed the product as the “ultimate Warren Buffett investment,” even using video grabs of Warren Buffett, but under the bonnet it wasn’t a straight purchase of Berkshire Hathaway shares. The product was a complex mix of loans and derivatives, and the marketing invited the inference of Buffett endorsement while the actual structure and risks were far less transparent.
Can investors claim tax deductions on interest for structured product loans?
Yes — the article notes some products allowed investors to claim tax deductions on interest for what was described as a “loan,” even when investors weren’t actually liable to repay that loan. It also points out Macquarie won an Australian Tax Office ruling supporting the tax deductibility of interest on a similar loan-like arrangement.
What do “capital guarantees” on these products really mean?
Capital guarantees often exist in the fine print and are tightly limited. The article warns these guarantees are defined in long product disclosure statements (around 100 pages) and may not provide the broad protection retail investors assume, so the actual extent of protection can be narrow and conditional.
How have regulators responded to the rise of complex structured products?
Regulators globally are moving to curb potential consumer harm: Belgium imposed a moratorium on selling complex structured products to retail investors while it develops tougher rules; the UK’s FSA published a ‘Product Intervention’ discussion paper; and Australian regulators such as ASIC have signalled increased scrutiny and intervention.
What did ASIC find about JB Global’s advice and marketing?
ASIC imposed licence conditions on JB Global after finding cases of inappropriate advice, failure to adequately investigate clients’ situations, inadequate consideration of product characteristics and risks, and marketing that may have been misleading by emphasising benefits without balancing the risks.
How did Belgium decide whether a product is ‘complex’ under its moratorium?
Belgium used a four-step process: (1) whether disclosure of the underlying value is accessible, (2) whether the strategy is overly complex, (3) whether the calculation formula is overly complex, and (4) whether there is transparency around costs, credit risk and market value. Products failing these tests can be covered by the moratorium.
What practical steps can everyday investors take when considering structured products?
Based on the article, investors should demand clear disclosure of the product’s underlying value, costs, credit risk and market value; read the product disclosure statement carefully (including capital guarantee wording); be sceptical of marketing that implies celebrity endorsement or easy returns; and seek independent advice if the strategy or calculation formulas are hard to understand.
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