Italian anti-austerity vote could halt structured products revival, fear providers

Despite strong growth in Italy's structured products market last year, bankers say the mood has quickly turned conservative following the elections this week

Following the recent Italian general election in which a majority of voters rejected austerity measures, further straining the country's relationship with the rest of the eurozone, the immediate effect on the structured products market is likely to be a halt on new issues, especially of leverage products, according to industry sources.

"A large part of the certificates market is comprised of investment products," says Nicola Francia, head of exchange-traded products for Europe, the Middle East and Africa at Royal Bank of Scotland (RBS) in London. "I would expect a freeze in all of those products over the next few weeks – at least until we see more clarity around the future government," he says.  

"Investors will look for portfolio protection and domestic banks will be reluctant to sell risky products. Nevertheless, there will be interest for capital-protected payout and leverage products for portfolio hedging of equity, BTPs [Italian government bonds] and foreign exchange rates."

Another banker at an Italian bank in Rome believes the uncertainty over the future for the economy could push more structured products into the market as banks try to compete with the higher yield offered by government bonds.

"The spread today [Tuesday, February 26] was a bit higher than in the past few weeks. It is going to be a difficult time for those banks that tried to beat the BTP and CCPs [floating-rate government bonds], so it might be that product structurers are going to think about selling more digital bonds. It's going to be easier to beat the BTPs and CCPs with equity-like products than with a plain vanilla or interest rate-like structured product."

Investors will look for portfolio protection and domestic banks will be reluctant to sell risky products

Government 10-year bond yields in Italy rose sharply from 4% to almost 5% following the election results, settling around 4.7% by March 1. Five-year yields are at 3.4%, having fluctuated between 3.2% and 3.7%.

Many market participants say it is too early to tell exactly what effect the political uncertainty will have on the financial markets. "At the moment it's just noise – there are no clear trends," says Fabrizio Boaron, head of investor solutions for southern Europe at Barclays.

Prior to the election, the Italian structured products market was looking healthy. Figures from the European Structured Investment Products Association (Eusipa), which include data mainly on equity derivatives and equity-linked products from six European countries, show turnover in Italy for listed structured investments practically doubled – rising by 96.9% to €733 million ($959 million) – in the final quarter of 2012 compared to the same period in 2011.

Italy was also one of three countries in which turnover for leveraged products rose, leaping by 47.1% between the third and fourth quarter of last year. "These products have a very good track record in all markets across Europe and those in Italy did very well in the fourth quarter last year," says Francia. "But after the election gridlock that we are now facing in Italy, the question is how the market will react. In that scenario, I would expect increased usage for hedging and short-term trading and less interest in long-term positions."

Boaron's experience of the structured products markets mirrors the Eusipa figures. "In the past few months, we have seen a pick up in volumes, especially in equities, the reason being that the macro-economic environment is mildly more benign. Some investors have started to wonder whether bond spreads are too tight in general for credit and whether equities have been beaten down too much in the past few years," he says. "There's no momentum as yet – more a slight change in sentiment. Investors are not taking action but they are asking themselves these questions."

Investors are still looking for products based on large, liquid indexes, rather than those based on specific shares, says Boaron. "The most popular products haven't really changed – autocallables remain pretty popular."

Despite the positive figures from Eusipa, RBS's Francia highlights that the figures look high because of the bad performance of structured products during the eurozone crisis of 2011. "The final quarter of 2011 was a very bad one for the Italian markets," says Francia. "All the underlyings suffered a lot. So that's why I can definitely see an upside trend this year, compared to previous years where there were better market conditions, less stress on funding for Italian banks and less stress on the yield of Italian government bonds."

The crisis saw more investors buy Italian government bonds as they offered yields of between 5% and 6%. "For the Italian investor, this was a big opportunity to buy bonds, which they considered to be quite safe, with a very good yield. The main flows went to the BTP and other Italian government bonds," says Francia.

"The crisis also led to a shortage of liquidity in the Italian banking system, which meant Italian banks were trying hard to get as much funding as possible by the end of the year. These two elements, which were quite exceptional, distracted investors and Italian banks from placing different things other than BTP or their own domestic paper," he adds.