Leveraged Note for a Retiree
Mr. Tan, 68, retired, has SGD 820,000 in liquid savings. He draws SGD 40,000 a year for living costs. His current portfolio is 55% Singapore equities, 35% investment-grade bonds and 10% cash. A relationship manager proposes putting SGD 250,000 into a two-year autocallable note linked to a single US technology stock. The note pays 12% a year if not called, has a 60% knock-in barrier and uses 5x leverage. The RM's pitch says 'capital protected at maturity' in the brochure headline, although the term sheet says principal is at risk if the barrier is breached. Mr. Tan says he does not want to lose principal and does not understand the barrier. He signs the risk disclosure after a 20-minute meeting. The branch manager is two sales short of the quarterly target and asks the RM to 'get it done.'
1. Assess the suitability of the proposed note for Mr. Tan.
Read the worked answer
The note is not suitable on the facts.
Key suitability factors:
- Capacity for loss: Mr. Tan needs SGD 40,000 a year from an SGD 820,000 portfolio, roughly 4.9%. A 5x leveraged single-stock note can lose a large part or all of the SGD 250,000 if the barrier is breached. That would materially impair his income plan.
- Objective: He says he does not want to lose principal. The note is principal-at-risk, and the brochure headline is misleading.
- Complexity: He does not understand the knock-in barrier, autocall feature or leverage. A 20-minute meeting and a signed disclosure do not cure that.
- Concentration: SGD 250,000 would be about 30% of his liquid savings in one stock-linked product, on top of his existing equity exposure.
- Income need: A 12% coupon may tempt him, but it is conditional and may be paid by giving up principal protection.
The RM should not submit the application. The misleading brochure headline should be escalated as a marketing-conduct issue.
2. What should the RM and supervisor do before any application is submitted?
Read the worked answer
The RM should stop the sales process and escalate, not complete the paperwork.
Before submission:
- Re-run the suitability assessment with documented capacity-for-loss and risk-tolerance evidence. If the client cannot explain the barrier and leverage in his own words, the product is not understood.
- Show him a downside scenario: what happens if the stock falls 45% and the barrier is breached, including the estimated loss and effect on his annual SGD 40,000 withdrawal.
- Consider suitable alternatives: a bond ladder, a diversified income fund, a capital-protected deposit or a lower-risk annuity, depending on his needs.
- If he still insists, require independent advice and a documented exception approved by compliance, not by the branch manager alone.
- Record the branch manager's pressure as a conduct risk. Sales-target pressure is not a suitability factor.
The supervisor should also review why a 'capital protected' headline reached a client when the term sheet says otherwise.
3. What documentation and escalation should follow if the branch manager insists on proceeding?
Read the worked answer
If the branch manager insists, the RM should escalate to compliance and refuse to sign the application.
The file should contain:
- The client's stated objective, income need, time horizon and aversion to principal loss.
- The product's leverage, barrier, single-stock concentration and worst-case loss scenario.
- The misleading brochure and the term sheet contradiction.
- The RM's suitability conclusion and the branch manager's instruction.
- Evidence that alternatives were discussed.
Compliance should:
- Place the sale on hold pending review.
- Interview the RM and branch manager separately.
- Check whether other clients were sold the same product after a similar pitch.
- Consider whether the branch manager's target pressure breached internal conduct rules.
- Notify senior management and, if client harm is found, the relevant regulator under the firm's breach policy.
A signed risk disclosure is evidence that a warning was given, not proof that the product was suitable.