01 Jul 2008, Sophia Morrell, Structured Products
"We are in the golden age of structured products," declared Guillaume Poli, chief executive of distributor Edmond de Rothschild Financial Services in Paris, who opened the Structured Products France conference in the French capital in May. France ranks fifth in Europe in terms of market volume for structured products, which reached EUR90 billion under management in 2007, according to Poli.
Capital-guaranteed structures are the mainstay of the French market, accounting for 87% of all products sold in 2007. Risk aversion has come to characterise the investment landscape in France, as it has the other countries that comprise what Poli referred to as the 'garlic belt' - France, Spain, Italy and Greece. Pensions aside, investors in these markets typically save throughout their lives to achieve specific targets, Poli explained. This means the idea of placing those investments in asset classes with an equity-like risk-reward profile sits uneasily with investors, and capital preservation takes priority. Nonetheless, Poli said these two trends are slowly beginning to converge.
It was the challenging three years between 2000 and 2003 which left even daredevil investors cautious, said Sandrine Bastide-Calori, director of marketing and communication at Banque Privee Saint Dominique. "Clients need security," said Bastide-Calori. "You have to offer the stock market, but without the risk." Part of providing this security means distributors must pay close attention to the sales process and investor protection, for which detailed provision has been made by both the French financial regulator, Autorite Des Marches Financiers (AMF) and the Markets in Financial Instruments Directive (Mifid). Many regulatory constraints must be taken into account, said Bastide-Calori, such as those relating to clarity in sales documents and the suitability tests for clients' needs.
The distributors are fairly unusual as independent operators in a market dominated by a handful of large issuers that use their strong existing retail networks to distribute products. Eighty per cent of issuance is controlled by just five banks, and 40% of total volume can be attributed to a single issuer, Poli explained. Paris has developed a reputation for training some of the world's most sophisticated financial engineers, who populate the trading floors of the biggest market players.
"Don't underestimate the culture of engineering here - the banks are full of people with a very strong mathematical background," said Rachid Lassoued, head of financial engineering at Societe Generale Securities Services (SGSS). However, Lassoued notes that this level of education is missing from the buy side. "The asset managers, private bankers and institutionals that are buyers of complex derivatives do not have the same level of understanding and information as the sell side," he says. "We take a pedagogic approach, trying to explain and simplify the concepts as much as possible. The underlying models and market parameters are meaningless if you don't have the analysis to go with it," he said.
"SGSS is looking at the balance between the buy side and the sell side and trying to bring the buy side up to the same level," said Lassoued. "We have access to pricing technologies and market data that most of them normally wouldn't be able to access," he said.
The trend towards transparency for investors and distributors in the French market is hardly surprising, as their primary desire is to see as much information as possible about a product. This does not mean that more complex products are completely off the agenda, but that investors want to be able to understand more about how such products are put together.
"There is a trend towards more transparent structured products, which include exotic payouts such as autocallables and worst-of structures," said Fabrice Zamboni, head of new products and structuring at distributor Olympia Capital Management. Zamboni's comments were made in the context of products that are structured on alternative investment strategies, namely hedge funds. France has given birth to some sophisticated developments in this space, such as a constant proportion portfolio insurance (CPPI) product that incorporates an option. This allows the investor's exposure to be increased when the funds perform well.
Structured products are the ideal vehicle for retail investors to expose themselves to hedge funds, Zamboni explained, because they offer a clear regulatory approved means of accessing such strategies, as well as giving leveraged exposure, or being tailor made to fit particular investor constraints.
Commodity and thematic index baskets are the latest trend in underlyings, explained Dang Co-Minh, chief executive of La Banque Postale Structured Asset Management (LBPSAM). Plays on thematic indexes have not yet captured the imagination of investors to the extent that they have in other regions, but do represent a growing trend in the market as socially responsible investing gains popularity (see chart).
LBPSAM's latest product in this area is Elanceo, a best-of structure that offers exposure to the S&P Clean Energy and the S&P Global water. If these indexes do not perform convincingly enough over the life of the product (between five and eight years), suffering from what Co-Minh described as the potential 'green bubble', then investors receive the performance of an index basket containing the Eurofirst 80, the S&P 500 and the Nikkei 225.
LBPSAM has been the only issuer to do an environmentally themed product this year, according to Co-Minh, although only 70 products in total have been issued in France since January 2008. However, the index trend may be the boost that this segment needs, and it is certainly a sector to watch. It is no coincidence that French market heavyweight Societe Generale recently celebrated the first anniversary of its own index range, which includes thematic offerings such as Global Carbon and Global Environment.
2008 Outlook: The regulatory challenge
Despite the plethora of rules and regulations issuing from varying bodies in an attempt to protect investors during the sales process, the spectre of misselling continues to haunt the French market.
In May, the French regulator, Autorite Des Marches Financiers (AMF) produced a set of guiding principles on the documentation accompanying the sale of financial products, re-emphasising that such material must be clear and not misleading. The ombudsman's report for 2007 showed that the number of complaints about the marketing of collective investment schemes increased during the year, particularly for structured and 'enhanced cash' funds. Specific complaints included "the non-receipt of prospectuses when subscribing to a fund, ill-judged recommendations from advisers and problems understanding a product's overall structure," according to an AMF statement.
The ombudsman's report highlighted multiple cases throughout 2007 in which it had not been made sufficiently clear to investors that a capital guarantee at maturity would exclude commission fees, and that additional returns would depend on the performance of the underlying. It was also noted that investors are becoming increasingly interested in the specific performance of their product, and will not hesitate to ask for a look at the books themselves. In one case, an issuer had accepted liability and agreed to pay the basic savings account interest rate on the investor's capital as compensation.
The obligations of issuers and distributors have been thrown into sharp relief by the controversy surrounding Caisse d'Epargne's Double Monde range of products. Double Monde was a six-year product in five tranches, launched initially in November 2001 by Caisse d'Epargne. As the name suggests, the products were sold under the proviso that investors might be able to double their invested capital, linked to the performance of 12 international shares. Now that these products have reached maturity, investors have been disappointed to find that not only has performance been flat, but that the bank's fees were extracted from the 100% capital guarantee. Caisse d'Epargne could be subject to further action following the complaints made to the AMF and another French consumer body by a group of dissatisfied investors.
The Benefic range, which was sold by La Banque Postale from 1999-2000, also continues to attract complaints for a second year running, with the past year seeing 12 separate claims settled by a total of EUR50,000 of compensation from the bank.