Stockholm provided the scenic backdrop to the second Structured Products Nordics conference, held in the Sheraton Stockholm hotel on Wednesday 11 and Thursday 12 June. David Hansson, managing director of structured investments distributor marketing at JP Morgan, delivered a compelling opening presentation on trends in structured products and the implications for the Nordics. "In Europe, it's very much about capital protection, whereas in the Nordics, it's mostly about growth," said Hansson.
As the demand for structured products expands across the Nordic region, dislocations in the market are becoming more acute and concentration of risk is increasing. If distributors continue to sell the same payouts demanded by end-investors, product manufacturers will continue to write and price these derivatives, thereby creating a concentration of hedging risks in the trading portfolios, he said.
One solution is to dilute concentration through diversification in client portfolios and hedging books. "We must actively push other payouts with attractive risk-return features and diversification benefits," said Hansson. Otherwise, sustained losses among product manufacturers could result in less capital allocated to hedging products while concentrated losses among investors might cause disillusionment with structured products. Hansson concluded by highlighting the need for a balance between risk exposure for end-investors and product manufacturing.
Also discussing market trends, Steve Goldin, vice-president of portfolio services at Standard & Poor's (S&P), delivered a presentation on trends and innovations in indexing. Goldin noted the proliferation of sharia indexes and suggested that while the theme has not previously been a hot topic for most parts of the Nordics, clients are increasingly enquiring about sharia underlyings. "There is an expansion of sharia indexes and overlay screens over existing and emerging areas of market interest," said Goldin. "Anything attractive will get that sharia overlay," he added.
But thematic is not just what is hot - it cuts across industry classifications and geographical exposure. In order to capture these themes that transgress boundaries, new ways of designing indexes are required. "Index innovation has led S&P to create a whole new classification system." said Goldin. Other identified indexing trends include an increase in custom indexes, an expansion in investment banks creating indexes and a movement away from complicated to simple payouts. "The increase of such products has long been a driver of index innovation," he said. With new structured products issuance in European retail climbing to over EUR266 billion last year - a definitive rise of 39% from 2006 - there is an increasing supply of fuel to drive index innovation in the Nordics.
One theme that permeated subsequent presentations as well as the champagne roundtable was the Markets in Financial Instruments Directive (Mifid). Anders Malm, a partner at law firm Oreum Advokatbyra, delivered a comprehensive presentation on when to implement Mifid. "What are people doing now? What is Mifid doing in practice?" said Malm. "We have the rules; now we are trying to get guidance, to choose where to go," he said. Different approaches to tackling the same aspect have resulted in inconsistencies in the directive's implementation, he added.
Malm then addressed the nebulous subject of classification, which requires products to meet certain criteria in order to be classed as non-complex. For example, one requirement stipulates that comprehensive information must be made publicly available and simple enough for the average client to comprehend. Nonetheless, Malm concluded that structured products do not qualify as non-complex investment products. "But this is not necessarily all that bad," said Malm. "Structured products are faring quite well with Mifid, despite a slow start," he said.
Continuing in the same vein with a presentation on Mifid, Annika Von Haartman, head of unit, prospectus and listing at Finansinspektionen, the Swedish Financial Supervisory Authority, discussed the differing policies in classing structured products as complex or non-complex. In Sweden, for example, the regulator's view is that only simple structured products such as index-linked capital-protected notes, linked to only one index, may be considered as non-complex. In contrast, the Finnish regulator has allowed a self-regulatory body to provide guidance, resulting in the view that most structured products are deemed non-complex if not labelled otherwise. Haartman also elaborated on marketing rules and the new powers bestowed upon Finansinspektionen to supervise marketing material. The quality of such material tops the priority list for the regulator in 2009 as it is not quite up to standard, said Haartman.
Another topical theme continually rising in popularity in the Nordics is structured products with emerging markets as underlyings. "What's driving the interest in emerging markets?" said Mikael Axelsson, chief executive of Oak Capital Group. "We have push effect from the issuer side and pull effect from the client side," he said. When there is a margin squeeze, banks are looking for alternatives to trade, while clients are seeing emerging markets as a trend through media exposure. Furthermore, emerging markets are still outperforming and outpacing the developed world in many respects, said Axelsson.
As a delivery vehicle providing access to emerging markets, structured products help to solve a number of investor issues. Emerging markets are highly volatile and structured products can offer capital protection. Structured products can also provide currency exposure flexibility, as investors may or may not desire FX exposure. On the other side of the coin, Axelsson said such products can be very complex, going against the current trend of making transparent products. "The underlying fundamentals in emerging markets are superb. We continue to believe the asset class is under-capitalised, under-leveraged, under-owned and under-valued," said Axelsson.
The benefits of hybrid products in volatile markets were presented by Mathias Westling, co-head of Nordic and Eastern European Region at RBS Global Banking & Markets. "The world has entered a new volatility regime in the post-credit-crunch bear market," said Westling. The problem with high volatility is that while high rates are good for the option, they bring competition from higher-yielding rates. "What can we do when options prices rise and equity markets don't perform? Can we use the negative spot-volume correlation to our favour?" he asked.
Westling discussed vol-stabilisation products, which give investors more confidence in the level of volatility the product is likely to experience, regardless of the market environment. The advantages of such products include lower volatility, which reduces option prices and means not overpaying for an underlying with implied volatility, he said.
The conference closed with a humorous observation from Roland Dahlman, head of management at Investerum Wealth. In highly volatile markets, there is a need for capital protection, said Dahlman. "If I want to play Russian roulette, I would have more fun wearing a helmet," he said. Given current volatility, Dahlman invoked the metaphor of the black swan coined by Nassim Taleb, to illustrate the futility in predicting the future as well as highlight that the seemingly impossible can happen. While there is no answer to catching a black swan, perhaps luck favours those who take a chance. After all, black swans do exist.
The week on Risk.net, July 7-13, 2018Receive this by email