October 2011

FRANCE: Transparent innovation

Cigarette-WarningSeveral factors could expand demand for structured products despite today’s hostile environment. But providers must work hard to explain their processes, writes George Mitton.
There is more than a hint of hostility to structured products at the moment. The UK regulator, the Financial Services Authority (FSA), is planning “health warnings” for investment vehicles marketed to consumers and has highlighted structured products for review. Independently, many investors are boycotting these vehicles because they believe they are illiquid, which is hampering sales in Europe as the debt crisis pushes investors to choose safe, liquid assets. French providers have it especially hard. Exposed to Greek debt and with their credit ratings gradually sliding, the French banks are looking less and less like stable, trustworthy counterparties. And yet, several factors could boost demand for these products. Volatility in equities means that investors who want to take risk are obliged to take out drawdown protection, which structured products can offer. The Solvency II directive is likely to increase demand for liability products and rising inflation is increasing demand for inflation-hedging tools. French providers recognise that they have a difficult job to do. Balancing innovation needed to answer clients’ needs while also satisfying their clients that they know how they work. Gilles Guerin is chief executive officer at Theam, the structured products business owned by BNP Paribas. He admits investors are more than usually suspicious of these instruments at the moment. “People want more transparency,” he says. “The days of, ‘here is a great structured product, trust me on this’, are gone. They want to understand what’s in it, and how the investment will behave depending on market conditions. The stress tests and scenarios they are asking you to go through so they can have a good grasp on what it will do in real life, are much higher.” This means companies must spend more than ever on explaining their products. It is not enough to have a tool that works. The client must understand how it works and be reassured that they can get their money out if something goes wrong. At the same time, competition is driving asset managers to create innovative products, potentially increasing the complexity. “It means we have to be ever more innovative and be able to explain that in very simple terms to investors,” says Guerin, who admits it can be a challenge to strike a balance between innovation and transparency. But the problem of explanation may be less onerous than some observers claim. The FSA’s proposed health warnings are designed to protect retail investors from buying products they do not understand. Yet the vast majority of structured product clients are institutional investors. “We are more focused on institutional solutions,” says Thierry Mirabel, head of structuring at Lyxor. Another problem with the FSA’s campaign is that it may overstate the hostility to structured products. The chairman of the UK’s Structured Products Association has pointed out that only a fraction of complaints to the FSA in the first quarter concerned structured products. Perhaps the outlook for structured products is not so bleak after all. One consequence of the Eurozone volatility is that those clients who want to take risks are interested in products that can help reduce losses on equities. These are a key product range for Lyxor, says Mirabel. A push will also come from the Solvency II regime, which will require insurers to state the market value of their assets and liabilities when determining their solvency position. They will also have to hold explicit capital to compensate for short-term volatility in these values. These requirements will push insurers to buy more downside protection as well as use structured products that include derivatives such as swaps and floors for duration-matching. Then there is inflation. Although it is running not much more than 2% in France, in the UK it is close to 5%. Pension schemes are worried about the impact of rising prices on their liabilities and are a promising target for structured products that hedge inflation. Though the eurozone uncertainty will continue to dampen interest in products that seem illiquid, there is strong underlying demand for structured products. The challenge is to explain to clients how the new vehicles work, and achieve a balance between innovation and transparency. ©2011 funds europe

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