An autocallable note for a retiree who needs income
Daniel, aged 74, retired six years ago, has £120,000 of investable savings: £95,000 in a building society instant-access account and £25,000 in an old managed fund. His state pension and a small annuity cover his regular bills. He tells his adviser, Rhian, that he wants about £6,000 a year extra to help his daughter and grandson, and 'not to lose money'. Rhian recommends moving £80,000 into a six-year autocallable note issued by a bank, linked to the FTSE 100 and two European bank shares. The note pays a 7% annual coupon only if all three underlyings are at or above 75% of their starting levels on the observation date; capital is returned in full only if the worst-performing underlying never falls below 60% of its starting level; otherwise the client receives the worst-performing shares or the equivalent cash. The key information document shows an unfavourable scenario of minus 32% at the end of year six. Costs are 2.2% up front and 0.4% a year. Daniel says his neighbour has one 'and gets 7%'.
1. Assess the suitability of the recommendation under COBS 9, including concentration and capacity for loss.
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On the facts as stated, the recommendation is difficult to defend.
Suitability requires matching. COBS 9.2 requires the firm to obtain information on the client's objectives, financial situation, knowledge, experience, risk tolerance and capacity to bear loss, and to recommend only what is suitable. Capacity for loss is a distinct question from appetite: it asks what the client can actually absorb without damage to their standard of living.
Concentration. £80,000 is two-thirds of Daniel's investable assets, and it is locked for six years. After the sale, £95,000 of his £120,000 would be in a single bank-issued structured note plus a small equity fund. A single issuer default or a breach of the 60% barrier hits most of his wealth at once.
Income that is not income. Daniel needs £6,000 a year (5% of £120,000). The 7% coupon is contingent on all three underlyings being at or above 75% on each observation date; if the condition fails, no coupon is paid and the target income disappears. A six-year note cannot be relied on to meet an annual income need.
Barrier is not protection. The 60% barrier limits the loss only if it is never breached on the relevant observation dates; the unfavourable KID scenario of minus 32% means roughly £54,000 back from an £80,000 investment. Daniel said he does not want to lose money, and a bank deposit or short-dated government stock ladder would meet both the income and the capital-certainty needs.
The neighbour's experience is social proof, not evidence of suitability.
2. How should the KID's performance scenarios and costs be presented, and what must Rhian not say?
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Scenarios. A PRIIPs KID must show four performance scenarios (stress, unfavourable, moderate, favourable). These are illustrations of possible outcomes under stated assumptions, not forecasts, and the KID must say so. Rhian should present all four, lead with the unfavourable case for a client who says he cannot lose money, and explain the mechanics that generate the numbers: the coupon condition, the 60% barrier, and the effect of the worst-performing underlying. She should also explain that a 7% headline coupon is compensation for risk, not a promise.
Costs. The 2.2% up-front charge on £80,000 is about £1,760, plus 0.4% a year - roughly £320 a year on the initial amount if no growth occurs. The KID must present these as a reduction in yield and as a cash amount, and Rhian should compare the net effect against the alternatives.
What she must not say.
- That the note is 'capital protected' or 'safe' because of the barrier.
- That the 7% is 'income' in the way an annuity or deposit interest is income.
- That the KID's favourable scenario is what the client should expect, or present a single figure as a projection.
- That the note carries the same protection as a bank deposit; the client's claim would be against the issuing bank, and deposit protection limits do not map neatly onto a structured note held as a designated investment.
Plain language. The client should be able to explain back what happens to his £80,000 in the unfavourable scenario.
3. What must exist on file before the sale completes, and what should Rhian do if Daniel insists on proceeding?
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Documentation.
- A completed fact find evidencing objectives, financial situation, income need, existing assets, knowledge and experience, risk tolerance and capacity for loss.
- A suitability report that explains why this product, why this amount, why six years, and what the alternatives were (deposit ladder, short-dated gilts, a smaller allocation to the note, or an annuity top-up).
- A record of the product governance assessment showing the note is designed for the target market Daniel is actually in - a capital-preservation retiree needing income is unlikely to be in it.
- Evidence that the KID was provided and explained, with the unfavourable scenario discussed and the client's reaction recorded.
- A costs disclosure showing the £1,760 and the ongoing 0.4% in cash terms.
- Notes on the neighbour's influence and the client's expectations, corrected on file.
If he insists. A client can accept a higher risk than the adviser recommends. The firm should either decline to execute the advised recommendation, or record a documented client-initiated instruction with the risks explained and acknowledged. What it cannot do is proceed with an advised sale it believes is unsuitable and paper over it afterwards. If the client's insistence suggests he has not understood the barrier, that is a Consumer Duty consumer-understanding failure, and the firm should reconsider whether to proceed at all. The file should show the reasoning either way, because the complaint or FOS referral will be judged on the record, not the recollection.