Market view: Spanish lessons

Spain's thriving structured products market can be explained in part by increasingly favourable tax treatment, but it has also been fuelled by the large margins available to product providers. Robert Benson profiles the market

The Spanish structured retail product market has grown dramatically in recent years and is now the second largest in Europe. In fact, relative to the size of the economy the Spanish market already ranks number one by a significant margin (see chart).

In 2004 gross sales volumes reached almost €18 billion, an increase of more than 30% on the €13.5 billion achieved only two years previously. What led to this rapid growth? And what can other European markets learn from Spain's experience?

The Spanish savings market has traditionally been dominated by the large retail banks and local savings banks, or Cajas. According to Banco de Espana, local savings banks such as La Caixa and Caja Madrid had a 55% share of all Spanish savings in 2004, compared to 37% for retail banks such as Grupo Santander and BBVA.

'Big two' dominate

As is the case in many other European markets, retail investors tend to be relatively unsophisticated and rely on recommendations from their local bank or savings institution rather than carrying out their own research or using the services of independent financial advisers.

This has resulted in a dominant position for the two largest retail banking groups, Grupo Santander and BBVA, and the local savings institutions as mentioned above.

In terms of structured retail products, Grupo Santander, which includes Banesto, and BBVA together account for about two thirds of the whole market, with the local savings banks taking the bulk of the rest. The market is well developed, however, with 45 institutions offering a total of 146 products in 2004, and anywhere between 20 and 30 products available at any one time.

The most popular form of investment has traditionally been the deposit account, but more recently the use of fund wrappers has been on the increase. The Fondos Garantizados de Renta Variable and the Fondos Globales have been the main fund types used for structured products.

These fund-wrapped products have achieved some remarkable successes in recent years and have been the main drivers behind the big jump in sales since 2003. The large retail banks have promoted them heavily, whereas the Cajas have tended to offer traditional, deposit-based products.

One explanation for the sales boom for fund products in the last few years is that their tax treatment has become more favourable. In particular, since January 2003 it has been possible to transfer money between funds without incurring tax. This appears to have led to a switch out of conventional funds into protected fund products.

In fact, all Spanish fund products have experienced a rise in sales, partly fuelled by the relatively large margins available to product providers. According to research by Lipper, the average expense ratio for all Spanish funds is the highest in Europe at 2.12% pa TER (Total Expense Ratio). The state funds regulator (CNMV) has already acted to try to reduce these charges, and last year introduced a requirement that the TER is included in all fund documentation.

More generally on the regulatory front, the CNMV is focusing on increasing market transparency. Last year, for example, new regulations were issued requiring all new funds to be registered with the state regulator. As yet, however, these requirements relate only to funds and not the structured deposit products that are offered regularly by most of the banks and savings institutions.

Blockbusters

A notable feature of the Spanish market in recent years has been huge sales of a small number of "blockbuster" products. March 2004, for example, saw the launch of the first tranche of Santander's Fondo Supergestión series. This four-and-a-half-year fund was linked to a basket of shares and managed funds and used a VAR-based portfolio insurance investment strategy to provide a minimum 100% protection level at maturity.

Backed by an extensive advertising campaign, the fund sold in excess of €7 billion, mainly during the first half of the year, to become one of the bestselling products in Spain's history.

BBVA has offered its own big sellers, such as their Extra 5 funds, the first two tranches of which attracted more than €3 billion at the end of 2003 and start of 2004. And more recently, Santander's Superseleccion Acciones funds sold in excess of €3 billion to more than 90,000 customers throughout January and April this year.

The success of these products is attributable not only to the large national distribution channels of the providers but, as noted above, the significant marketing resources they receive. This covers branch-based advertising but also includes mass media such as newspapers and television. In fact, Santander was using television advertising for its Supersatisfacción products as long ago as 2002.

The idea seems to be to promote the product almost as a brand in its own right. Customers then become familiar with it and recognise it when discussing their investments. Once the name is established and sales are successful, a series of products with the same brand can then be offered over a period of a several months to maximise the return from the campaign.

Spanish peculiarities

Other peculiarities of the Spanish market include offering small gifts to investors when they invest and very low minimum investments thresholds, some of which can be as small as €300.

Another reason for the success of structured products in Spain may be the predominance of guaranteed and capital-protected products. In fact, almost no capital-at-risk products are sold. The defensive nature of these products could be one of the reasons why their providers' are willing to launch costly marketing campaigns, since their inherent financial and reputational risk is deemed to be low.

Indeed, many products in Spain offer a minimum coupon in addition to full capital protection. According to StructuredRetailProducts.com, 41 of the 109 products striking in 2005 offered a minimum coupon in addition to a capital guarantee.

Low interest rates across Europe mean that the potential for upside equity participation is small. This has resulted in the use of CPPI and other portfolio insurance techniques, as well as several more exotic options. One common payoff in Spain is the so-called "whale" approach. This is a type of call option where the return is calculated as the difference between the final reference level of the underlying and the strike level, all divided by the final reference level. So in effect, as the underlying rises, the return increases by smaller and smaller degrees, so that the product is effectively capped without having an explicit maximum return built in.

In general though, straightforward, uncapped call products dominate, with the local Ibex 35 index as the preferred underlying. Share baskets are also very popular, and usually contain well-known Spanish companies that appeal to local investors. Baskets of managed funds are seen, however, as are more adventurous indexes, such as the FTSE Xinhua offered recently by Bankinter.

The Spanish structured products market has so far avoided any of the high-profile problems seen in other, more mature European markets. Perhaps Spain is fortunate in developing later and has been able to learn from the experiences of other countries.

In turn, one lesson that Spain seems to offer retail product providers elsewhere is to offer very low-risk products, preferably with some kind of minimum return and a short maturity (most Spanish products come in under five years). Linking them to familiar local indexes or shares and backing them with extensive marketing and promotional campaigns is another.

Robert Benson is the managing director of Arete Consulting, the owner of www.StructuredRetailProducts.com. He can be reached at [e-mail]