14/09/2022

Though they have become few and far between in the sector over the previous decade, IDAD have recently released their latest capital ‘protected’ plan, which along with a steady increase in issuance of structured deposits, has duly prompted us to dispel an all-too-common misconception regarding the two plan types.

The key similarity, and potential cause of confusion, between deposit based and capital ‘protected’ plans is that they each protect investors’ capital from downside market risk. A typical capital-at-risk plan will protect investors original capital against a fall in the underlying index up to a certain point – deposit based, and capital ‘protected’ plans will return the original capital in full regardless of the extent of the fall in the underlying.

However, there is a fundamental difference between these plans in relation to risk that shouldn’t be overlooked by investors – counterparty risk. In this instance counterparty risk refers to potential that the issuing financial institution might default on its contractual obligation.

The Financial Services Compensation Scheme (FSCS) provides a layer of protection for depositors, protecting up to £85,000 per bank, per individual. This protection extends to include structured deposits which, to an extent, provide investors with protection against the counterparty bank failing.

A capital protected plan is not however a deposit but simply an unsecured note issued by the counterparty where the terms oblige the issuer to return the investment in full at maturity.  As such, the risk of default is an inherent risk for which a potential reward is being paid and if that risk manifests into a loss because of default, it is not a loss that would qualify for FSCS cover.  As such, despite their name, capital ‘protected’ plans do not provide protection in the event of an issuing counterparty defaulting, under which circumstance the return of capital would be subject to insolvency proceedings.

 

Downside Market Risk

Counterparty Risk

Typical Taxation

Capital-at-Risk

Yes

Yes

CGT

Capital ‘Protected’

No

Yes

Income Tax

Structured Deposits

No

No*

Income Tax

* Subject to FSCS compensation limits

Following the risk return trade off, investors should expect to be better rewarded the more risk they take and as such, a capital ‘protected’ plan should offer some enhanced return compared to an otherwise equivalent deposit-based plan.

Full details of all plans currently available, including several structured deposits that are Lowes ‘Preferred’, can be found here.