It was never that important to define the valuation of a structured product during the lifetime of the investment. Although it was fine at maturity, there was little point in attempting to value a product before, as the most likely reason for selling a product was an immediate need to liquidate. And that meant a sale of the product back to the issuer, which had some liberty to pay you what they thought fit.
Valuation is a particularly difficult concept in structured products because what you are getting is an investment that is most likely to pay you a certain amount (otherwise known as a defined benefit) at the end of the term.
It is regulatory pressure, based on a greater need for protecting the consumer, that has highlighted a need for greater transparency in what the value of a structured product is at any time during its life. While the logic is fine, that the valuation of a structured product is an extraordinarily complex science, which has naturally attracted the interest and the modelling skills of technology providers.
The best example of the difficulty can be seen just after the product is launched. Once the distributor has taken its commission, the producer has taken its cut, and maybe a fee has been spent on a derivative, a product that started life valued at 100 may be suddenly ‘worth’ 93 or 94. This instant valuation will probably not correlate with the final payout from the investment, which might include a promised coupon amount paid quarterly, or even annually, irrespective of any calculated or perceived ‘value’ the product may have.
The US Securities and Exchange Commission is the latest regulator to shout out the results of an investigation into the valuation of structured products. After a series of interviews with product producers, the busy regulator has deemed it fit to provide guidance on what valuation really means for these products and how it can be reached. Now it is over to the technology producers to work out what all of that means and how valuation can be commoditised.