The retail quandary


It’s interesting to witness the wide range of responses when you say “retail” to credit derivatives traders. Some look horrified, and begin a long diatribeon how retail investors may be bewitched by the high headline returns on structuredcredit products without having too much clue about the risks involved. Otherspoint to the mind-boggling complexity of some of the equity-linked products approvedfor the retail market, and add that so long as the risks on credit structuresare properly explained, investors can benefit from a highly rated basket of creditsthat offers a higher return and more diversity that a similarly rated corporatebond.

Certainly, there’s a case for both arguments. On one hand, principal-protectedfunds collateralised by AAA or AA tranches of synthetic CDOs undoubtedly offera yield pick-up that can boost investors’ equity participation, as wellas a relatively high level of subordination and diversity. Indeed, an AAA ratedCDO tranche would actually have a higher rating than the majority of banks thathave traditionally guaranteed these funds. Depending on the size of the portfolioand level of subordination, even a handful of defaults would not necessarilyerode the investor’s principal, bankers point out.

Still, it’s a fair point to question whether retail investors truly understandthe risks. Will most skip over the part in the prospectus about subordination,diversity scores and loss of principal, and just focus on the relatively highcoupon? Probably. But is there any way around that, short of sitting down withevery investor and making sure they are aware of the risks? Banks already dothis with their institutional clients – but this is an obviously impossibletask for the retail market. How far should banks or distributors go in theirobligation to make sure that investors fully understand the risks?

Either way, there’s no doubt that more and more houses are looking to tapthe retail market with credit-risky products. In the last month, ABN Amro haslaunched series three and four of its HY-FI portfolio credit-linked notes forAustralian retail investors, having already tapped New Zealand’s retailmarket a few months ago with series one and two. In Singapore, retail investorshave been able to invest in principal-protected products collateralised by syntheticCDOs. It seems a dead cert that there will be more going forward.

But that’s not to say the institutional investor base is being ignored.Over the last month there’s been a flurry of deals right across the region,despite the ongoing squeeze in credit spreads. Once again, UOB Asset Managementcontinues its prolific form with yet another managed synthetic CDO – itsfourth in the space of a year, and three more than its closest rival. Meanwhile,BNP Paribas has structured its largest ever Serena Finance arbitrage deal inJapan, at a time when the CJ 50 – a multi-dealer index tracking the 50most liquid credit default swaps in Japan – is at just 30 basis points.And it seems the pipeline will remain reasonably strong for the remainder ofthe year.

Meanwhile, Asia Risk this month publishes its annual 2003 awards winners – thoseinstitutions that have best demonstrated an ability to adapt to customer needsand meet their requirements on both the asset and liability side of the business.Competition was probably the fiercest it has ever been this year, but our winnersrepresent those institutions we feel have stood out from the crowd. Our profilesbegin on page 9.

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