Structured Products Americas: some welcome consistency in the complexity debate

Richard Jory reports from the Structured Products Americas conference in Miami

The investment of time and resources by regulators into structured products has been nothing short of astounding, but, despite the progress in the creation of new rules, no progress has been made towards establishing an industry nomenclature that would provide some consistency in the understanding and presentation of the products themselves.

The lack of consistency in nomenclature across the world has been noted, though not acted upon, by the regulators, and the message from Bill Hayden, senior director for emerging regulator issues at the Financial Industry Regulation Authority (Finra), echoed that of others at the Structured Products Americas conference in The Biltmore Hotel, Coral Gables-Miami on May 3. "The standardisation of nomenclature is being discussed, but will be a monumental task," said Hayden, speaking at the conference.

An agreement standardising the language used to describe products remains under review by the US Structured Products Association (SPA), though SPA chair Keith Styrcula noted that little progress was being made with this long-term project.

The core of Hayden's speech was based around the approach that Finra has taken to complexity, specifically of structured products. Hayden said the regulator has presented a "consistent message", before adding that the "focus on retail structured products by Finra is not negative". (See News section.) Referring to guidance note 12/03, Hayden explained that the consistency of Finra's message was necessary due to "the non-homogenous nature of the community [of broker-dealers] over which Finra has jurisdiction". Ultimately, the regulator decided to avoid a definition of complexity "because it is so difficult and also not desirable because it changes over time and is different for every firm. The decision was made to leave the definition to circumstances and analysis".

The early sessions of the conference were also dominated by anticipation of new rules and regulations from the US Securities and Exchange Commission (SEC) and, to a lesser extent, Finra. The fear of fresh action from the SEC was the most pressing, sparked by the publication of a letter sent to certain issuers on the regulator's website on April 13.

With interest rates low, pure retail is chasing yield

"Process and gatekeeping issues are all part of the strategy to catch people early and avoid blow-ups," said Linda Chatman Thomsen, partner at law firm David, Polk & Wardwell, speaking on the roundtable. "You should assume that structured products will be caught up [in the ‘complex' web] because that will be the result of any analysis taken after the event," she said. Hayden's position on this was: "Regulation is always going to be, in part, reactive. We are not saying about complexity that we will know it when we see it, but we expect firms to do some kind of analysis about whether they will treat a product as complex or not."

 

Mitigating turbulence

Joe Fernandez, president of Fendz Asset Management, said he anticipates greater use of structured products in the US. "I really like structured products," he said. "You never know when you're going to get another market like in 2008/2009, and they are good during turbulent times."

On the need for transparency, Fernandez noted: "[Salesmen] need to explain how the product fits into an investor's overall asset allocation strategy, and how it helps the overall model. Then I get the client to sign that document [which includes this information]. Then they settle down and allow the product to do its work."

Transparency begins with the literature on offer to investors but, while most people at the conference said the quality of this material had improved, some said problems remain. "I see it all: the good, the bad, the ugly and the hunky-punky," said Dayna Kleinman, first vice-president and senior product manager at Robert W Baird, a wealth management firm in Milwaukee. "It has got better, and the one- or two-page recaps help in that they turn the sales process into a talking game. "We require financial advisers to refresh their structured products information every five to six quarters, partly because of the constantly changing structures," said Kleinman.

The better-quality literature has been well-received. "We shamelessly steal everything we can from conferences, as long as the copyright works," added Schwartzman. "Issuers don't mind."

Schwartzman was passionate about presenting information clearly to clients. "We use graphics, not tables," he said. "If you can't explain something relatively simple, you can't just say it's complex." Fernandez and Kleinman both supported the use of graphics. "It's the future. We need a structured products iPhone app," said Kleinman.

 

Optimism

The unpredictability of current financial markets has made structured products based on market-neutral strategies increasingly popular, particularly with high-net-worth investors, said Nicholas Parcharidis, managing director and head of Americas sales at Citi private investor products in New York. "With interest rates low, pure retail is chasing yield," he said. Citi is also offering replacement strategies for equities and more conservative ways to access the asset class, and there is a prevailing theme of wealth preservation, he added. Those themes were predominant throughout 2011 and Parcharidis expects the story to remain the same this year, and possibly even into 2013.

Speaking on a panel entitled ‘Diverse offerings for a diverse range of investors', Thomas Mench, chairman and chief executive of Mench Financial Investors, said there has been a shift back into equity-based products as interest rates remain low. Tim Stoddart, managing partner and president at CIM Advisers, who was also on the panel, said credit risk remained a concern.

Investors are also turning to exchange-traded products (ETPs), particularly those based on commodities, according to Hennion & Walsh's Mahn. "ETFs are transparent, tax efficient, less costly and passive, but they have a tracking error; ETNs deal with the tracking error," says Mahn. "ETPs based on commodities help investors avoid the ugly twin sisters of contango and backwardation." Mahn noted that there are around 220 ETPs offering access to alternative investments, equal to 16% of the total ETP universe.

Tessar went on to present a new way of looking at structured products, including a matrix based on the degree of risk and the potential for loss. "If the potential for mis-selling is extraordinary but the potential for loss is low, then does that make it a bad product?" he asked.

Finally, regarding the question of whether increased legislation is a good thing, Tessar cited three industries - cars, medical devices and mutual funds - as examples of the effect of extra regulation. "I want more regulation now, as fast as possible," was his parting message.

 

Awaiting onshore products in Brazil

The wait for legislative developments in Brazil that make it possible to create onshore structured products will be over by the end of the year, according to Parcharidis. He is not the first person to make such a bold statement at the Structured Products Americas conference - the same thing was suggested in 2010 and was stated even more categorically at last year's event. "We are seeing US retail appetite for US dollar paper that is based on local Latin American currencies," said Parcharidis, while noting that 27% of the US population have Latin American links or origins.

As far as buyers in Latin America are concerned, Carlos Felipe von Hapsburgo, director at Habsburgo & Associates in Mexico, gave a frank assessment of their degree of financial knowledge. "What do they buy?" he asked. "The client doesn't buy anything; we do. A plain structured product is just a bond and an option, which is a call. It's very simple, but the client will not understand it. It is a question of finding a willing buyer who has confidence in you and that you know what you are buying."

CIM Advisers' Stoddart echoed this point. Structured products are sold, not bought, he said. "Adviser education is where we spend most of our time. The question isn't whether we can educate investors, but whether we can educate advisers sufficiently."

Brazil and Mexico are the only large structured product markets in Latin America, but red tape is a big issue in those countries because there is a lot of protection for local banks, said von Habsburgo.