How traders should choose new financial products

At a time when traders are faced with a huge number of new financial products, it would be important for them to know some of the important criteria for choosing these products.

In the best interest of customers and markets

The most important thing about financial products is that they should have the ability to act in the interest of traders and also the ability to work for the stability of the entire financial market. To achieve this goal in 2018, the concept of Product Governance was introduced across the EEA to ensure that companies that manufacture and distribute financial instruments and structured deposits act in the best interests of customers and markets at all stages of the product or service life cycle. Product governance is the process of creating, maintaining, and retiring financial products to ensure the customer receives a product suitable for their immediate and future financial goals. Providers and distributors must treat customers fairly and provide good value throughout the product's life cycle. For product governance, a company must conduct its business with integrity with due skill, care and diligence and must take care to organize and control its affairs responsibly and effectively, with adequate risk management systems.

Scenario analysis

Traders should be cautious when choosing whether to buy a new financial product from a company that manufactures or distributes it to them. When a company undertakes to manufacture or make a financial product available to traders, it should do a scenario analysis of the financial instruments it provides and assess under which conditions risks may arise for end customers. The company evaluates the financial instrument under negative conditions covering what would happen if, for example, the market environment worsened. Or if the manufacturer or the third party involved in the construction and operation of the financial instrument is experiencing financial difficulties, and thus counterparty risk arises. It should also analyze whether the financial instrument fails to become commercially viable or if demand for the financial instrument is much higher than expected, straining the firm's resources or the market for the underlying instrument.

Analyze the design and features of the financial instrument

The design and features of the financial instrument should not adversely affect end customers, nor should they lead to market integrity problems. Essentially, the financial instrument should not allow the company that created and provides it to be able to mitigate or spread its own risks or exposure to the underlying assets of the product to its customers/traders. In addition, before deciding to proceed with the release of the product, the manufacturer should consider in advance whether the financial instrument is designed in such a way that it is likely to threaten the orderly functioning or stability of the financial markets. Possible conflicts of interest that are incorporated in the design of the product, and relate to remuneration incentives of the personnel of the companies that manufacture or provide it, must be taken into account.

Cost of the charges, renumeration conflicts & contrary trade exposure

A very important parameter regarding the evaluation of a new financial product is the cost of the charges of this product. These costs should be compatible with the customers' needs, goals and characteristics, while the charges should not undermine the performance expectations of the financial instrument.

Also, costs or charges should not exceed or detract from the expected benefits associated with a financial instrument.

It is very important that the fee structure of the financial instrument is appropriately transparent to the customers/traders in the sense that it should not obscure the manufacturer's and/or the distributor's fees. Also, it should not be too complicated so that it can be easily understood.

A particularly critical parameter is the one that concerns the possible conflicts of interest regarding the remuneration of the personnel who manufacture and distribute new financial products so that their motivations are taken into account. If their remuneration conflicts with the interest of customers and the market, appropriate measures have to be taken.

In terms of analyzing potential conflicts of interest, clients/traders will also need to assess whether the financial instrument provided by a manufacturer or distributor creates a situation where clients/traders may be adversely affected,

• If they get a trade exposure contrary to the one the manufacturer previously had, or

• If they get a trade exposure contrary to what the manufacturer wants to maintain after the product is sold to clients/traders.

Identifying the customer to whom the financial product refers

The most important feature of a financial product is to have the ability to identify the customers to whom it is addressed so that the features and objectives of the product are compatible with those of the customers. This determination should be based on both quantitative and qualitative criteria.

So,

• The risk/reward profile of the financial instrument should be consistent with that of the clients while

• The design of the financial instrument should be based on features that benefit the customer/trader and not on a business model design based on negative customer/trader outcomes for this instrument to be profitable.

Traders, when choosing a financial product, should fully recognize the following issues

knowledge and experience

To what extent do you have the knowledge and experience to fully understand the product provided? For example, do you understand what leverage means for derivatives or how structured products with complex performance profiles work? Can you identify how these products generate returns? How much hands-on experience do you have with a relevant type or the relevant features of a new financial product?

If you have limited or no experience in a particular type of financial product, then you could compensate for this lack by attending training courses.

Economic situation

A very critical factor concerns the financial situation of the customer/trader. As a customer/trader, you should be able to calculate how much you are able to cover any financial losses that may arise from the acquisition and use of a financial product. Ideally, you should be able to determine the percentage of financial losses you can afford. A good approach could be to determine the maximum percentage of your assets you can lose in relation to your exposure to a financial product.

Risk tolerance

The risk/reward profile of the financial product must match that of the trader/customer. It is important for you as a client to be able to clearly distinguish whether the product is "speculative" or whether it is a "risk balanced" product or whether it is a "conservative" product in order to assess whether the financial product fits your risk profile.

Since the definition of risk has different approaches, the criteria that must be met to categorize a product should be clarified. Companies manufacturing and providing financial instruments should use the risk index set by the PRIIPs Regulation or the UCITS Directive, where applicable, to meet this requirement.

Client goals and needs

As a client, you will need to investigate whether the financial product being promoted identifies your investment objectives, including your wider client's financial objectives or the overall strategy you follow when investing.

For example, it is good to clarify each product's expected trading or investment horizon. If the horizon is short-term, the product is kept for a short period of minutes, hours or days, or if it is a product that can be kept for a medium or long-term horizon of months or years. Time horizons largely determine customer expectations for each product being promoted.

Traders should thoroughly analyse financial product features to understand whether the product provided to them is suitable and compatible with their objectives and investment profile. Any deviation is dangerous as it can bring unspecified negative consequences that are best avoided.

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