Although complex products can provide benefits to you, there are certain risks and potential disadvantages involved in investing in complex products. These risks and disadvantages may not be apparent, or easy to understand. You need to be fully aware of these risks and ensure you sufficiently understand the key features of a product in order to make in-formed investment decisions.
Liquidity risk is the risk that you will be unable to sell the product easily if you need to do so before the end of its term. If your product is not liquid, which is often the case for complex products, it is highly probable that you will have to sell the product at a heavy discount from purchase price (and you will therefore lose money) or will not be able to sell it at all.
‘Leverage’ is a term used to describe ways or strategies to multiply potential gains and losses, such as by borrowing money or using products like deriva-tives. It may be suggested to you that you invest with leverage in order to possibly achieve higher returns, but you must keep in mind that leverage can easily multiply losses too.
Market risk is the day-to-day risk of losses arising from movements in market prices. Complex products can expose you to several market risks because they are often designed to invest in separate under-lying markets (for example, in shares, interest rates, exchange rates, commodities).
Credit risk is the risk that the issuer of the product or a firm it deals with defaults and is unable to meet its contractual obligations to repay your investment.
Certain instruments are rated by credit rating agencies. If you are considering investing in a rated instrument, you should ensure that you understand what the ratings mean. A low rating will tell you that there is a higher risk of the issuer defaulting, and you will not get back the money you invested. A high rating indicates that the chances of an issuer defaulting are much lower, but it does not necessarily mean that the investment will provide the return you expect. You should also be aware that the rating of an issuer may change during the lifetime of the product.
Cost of complexity
Complex structures within a product can mean the product has a higher cost because you are paying for the product’s underlying features. Also, fees and commissions are usually built into the structure of the products, and are therefore not readily apparent.
The information provided above has been prepared by the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA). ESMA is an independent authority of the European Union and its members are the national regulators responsible for securities and investment services business. The EBA is also an independent authority of the European Union and its members are the national regulators responsible for banking business. The MFSA is an active member of ESMA and EBA. More information about ESMA is provided here: www.esma.europa.eu. The EBA's website is www.eba.europa.eu.