Structured Products Roundtable Part 1

There is a big disconnect somewhere between net end cashments and net investments. That is why I think the products that are designed now over the next quarter have to be well enough positioned to make that investment when it comes, and that applies to collectives whether structured or not. I think the industry has to wake a little bit and give itself a shake because we will come out of this storm. There is nothing more certain than that. The market is cyclical. Yes it has been a really turbulent four or six weeks [leading up to the roundtable] with unprecedented levels of volatility that just are not going to go away. 

The next twelve months are going to bring more volatility across the globe and investors still have to make return on their investments so the products have to be much more suited to the conditions. There is no point putting our heads in the sand and waiting for this to go away, because it is not going to go away. We have to redesign and adapt the product set to suit the current investor.

MO: I am not going to comment on the global financial services industry because the only part of the market we know is the UK. Has it been hit more or less than other markets by the financial crisis? If you look at the market and what is there, in the UK, Lehman Brothers had 20 products worth around £80m as against £2bn in structured products. It was a very small part of the marketplace. How is it affecting it going forward?

Many of the IFAs that we have dealt with did not write business with Lehman Brothers, or did not want to write business with Lehman Brothers because it did not necessarily pass the smell test, which is always going to be something that people are going to look at. So, I do not think the market for structured products has been hit. I think one of the things that people are starting to focus on a bit more is actually ‘ok if I am now comparing products I need to compare on a real basis.’

It is not that open-ended funds are good and structured products are bad, or that guaranteed funds from AIG are good or bad or whatever it is. It comes back to people designing portfolios, and financial advisers doing a good job for clients over the long term.  And it is actually about giving them good products that they can continue to put in their box to be able to sell. 

What all of us have got to do - and it is not just structured products it is long only funds too - is look at what they are putting into the marketplace to enable investors and those intermediaries who advise them to get the right products to put in their box. There are lots of products out there. Let’s make sure that we all have the right products, so that advisers can make sure their clients get the right kind of products going forward.

CJ: I agree with both Gary and Mark. To deal with Gary’s question about where the money is going: I can’t speak for the world but I can speak for my own client base. It is going into deposit takers, but no more than £50,000, whoever [the deposit taker] might be. It could be the strongest one in the country but no more than £50,000. My youngest son runs a security company and they are selling more safes now than they ever did, because people are going into hard cash. And I quite believe that - cash at home in a safe. Guaranteed bonds of course are still a favourite. I am not here to sell guaranteed bonds, but you cannot get away from the fact that in these times they are guaranteed. 

What Mark said was absolutely right. As IFAs we need products that our clients want. I only make money if I sell products that they want, not what I like. Certain products are offered to me, which I would not touch with a barge pole for a number of reasons. I am not going to say which ones. But, despite what’s happening the FTSE 100 is still a favourite index with my clients, particularly because now it is relatively low. So as far as I am concerned the market has improved as a result of the current crisis.



Colin Jackson

RS: I think the last comment is going to be correct. I think the market is going to benefit from the current crisis. I think the financial system will emerge from this stronger and better suited to purpose than it was before. I think the UK has got off relatively lightly, which may sound an odd thing to say because of the number of banks that have been affected by the convulsion that has gone through the financial markets in the last few weeks. But the fact is that no depositor with a UK institution has actually lost money. Some offshore depositors with offshore institutions may lose money but no depositor has lost money.

While as Mark says the Lehmans default has had relatively little impact on the UK structured product market it has had a big impact elsewhere such as Germany, for example. I was told at the weekend by the German asset management industry that investors have lost about €500m. Similarly, we have not had in the UK the problems that the money market funds in the US and continental Europe have had. So I think the UK has got off relatively light.



Left: Richard Saunders and right: Barney Hatt

BH: Are there any key issues facing structured products, especially off the credit crunch/bank failures?

GD: Credit. Absolutely no doubt about it. The last three to four weeks [leading up to this roundtable] have seen enormous increases in phone call requests not just about our own products but other companies’ products, [including such questions as] how to break through the credit rating, is it actually worth anything, where can we find other information, what is counterparty risk? The list goes on.

So there is absolutely no doubt that investors are going to advisors asking for more information on what this credit [situation] actually means and what is counterparty risk. And as a result of that we have put together a two-week package for the last fortnight in November to take these issues out to the market and address them head-on, because we have done nothing but that in the last month. So it makes sense if we take it to market and invite IFAs along to that debate. It is not going to go away. It is going to get worse.

When interest rates start to come off, as they will, the perception in the market will be that things have got worse. In actual fact the industry is using the only thing at its disposal – interest rates – to try and manage the economy, to try and grease the wheels of the housing market. The problem is inflation is going to continue to rise. I think the news for the industry is all positive in an ironic kind of way, but it is massively important. Explaining credit to IFAs is difficult enough, explaining credit to clients from an IFAs perspective it must be nigh on impossible.

And to make matters worse it is literally impossible for advisors to get information out of the banks. That is another big, big issue, which is why I think we’ll see counterparties named within products now - and Mark is better placed to comment on this - or at least disclosed on request if able to do so, to try and give a little bit more comfort to the end investors about what they are actually buying.

MO: I would just go back to a few years ago when there were some pretty smelly structured products around. There was all this high income stuff that crashed spectacularly. It was not necessarily well structured. There is this lovely triangle, as far as I am concerned, made up of a product provider, an intermediary and a client. And if that triangle is not equally weighted and is not working in the right way then one of those parties is going to lose out.

Some of the advisers might have done quite well put of high income products last time round, some of the product providers probably did very well, the client got nothing. I think this time round most people have gone through the smell test. IFAs are not silly. They have looked at it. They ask questions of us all the time. What sort of investment banks do you use? And we will say: 'We are probably using one of three'. If we can name them, we will name them. If we can’t name them, we will give a reason why we can’t name them, which might be because actually it is going to affect what they are doing and therefore they are not in a position to have it named because it is going to be a prospectus offering, therefore it causes a problem. 

But from the smell test point of view, is it a product that sounds too good to be true, does it look right or does it just smell wrong? We always go back to that and the IFA’s and clients go and look at that as well. The clients are not silly. We look at the amount of money that was tied up in some of these banks. It was not huge sums of money, really, compared to what is within the banking system. This is people that are in a different type of box. The comment about €500m in structured products in Germany, [well] that is a tiny figure compared to what the banks have lost themselves.

RS: It is not a small amount to German investors.

MO: If you look at that figure and look at what has happened in terms of banking values and how that has gone down, and if you look at long-only funds they have lost billions of pounds of value. So, when we talk about structured products we talk about £80m in the UK or £100m in Germany. These are not vast amounts of money when we look at what has been lost in terms of global stock markets.

I think all of this comes back to one thing that Colin said, which is that clients are spreading money around. Clients do not want to have all their money with one structured product provider. They do not want to have all their money with one guaranteed bond provider. They do not want to have all their money with one long-only equity house. Clients and IFAs in the main are pretty sensible people who spread the money around. They do not want products that answer all their investment prayers. They spread the money around, and that has always been the key.

I think sometimes people have gone into this approach where ‘wow, is that a wonder product?’ There is no such thing as a wonder product. The wonder product is the one that always explodes. So it comes back to a good spread of products. You don’t just go with one bank. We know that Barclays are out there and Barclays write lots of business, Investec is there and writes business, Citigroup writes business and JP Morgan writes business. It is all about clients spreading money around and not just running with one entity all the time. It is about spreading risk and spreading reward and I think from a client’s view that must be one of the key things, there is no one answer to investors' needs.

CJ: I agree

RS: Can I just respond to this? €500m is not a lot in relation to the assets within the banking system or indeed of the asset management industry. The pots that it was in though were actually a hell of a lot of money to the individuals concerned, because the point about the German market is that it was very heavily retail, and this was people putting their life savings into these products. When they blow up they are not diversified in the way that you say they should, which of course is right. They probably have not taken advice. They have gone with the sales pitch. You can write off €500m as not being worth it, but believe me to a lot of the people concerned it was a hell of a lot of money.





Richard Saunders

GD: I think also it is relative. When you look at the UK market even at, tops, £10bn this year, it is an insignificant number compared to the continent. Yes the regulation in Europe is not as tight but not for that reason. The banking sector is much more advanced than it is here in the UK, and the market for structures is in excess of £100bn annually, in fact way more than that in some countries in Europe. Therefore when you weigh up the German loss, the French loss and the Spanish loss, and all the other losses in Europe, it is quite a significant amount of money. But in relative terms in the UK it is probably comparable because our market is much, much smaller and much less advanced.

Can I just pick up on the smell test comment? I quite like that. From an advisor’s point of view – and this is a rhetorical question Colin – spreads have widened now to the extent that you are, in inverted commas, ‘for the take’: ‘AA’ rated banks, from ourselves ‘BBB+’, the spreads are almost identical now. Without giving names we know what the funding rates are because at the manufacturing level we see what they are.

We can see what the prices are from other banks, and we can compare and pitch accordingly. The problem is that there is very little to choose between a bank issuing it ‘AA’ and a bank issuing at ‘BBB’. Therefore I think it is going to be very difficult for an advisor to smell a product and smell a rat, the obvious ones excepted.

When you look at things that are multi-indexed or a multi-stock or very specific to a sector in the market, and you open it up and just think 'wow', [then] just put it down because you don’t get anything for nothing. I do agree with that. But when you start to read and compare products – because we price as you guys do regularly – it is extremely difficult for an advisor to then disseminate between wheat and chaff. All they have got is credit ratings and we all know what credit ratings are worth in the current climate. I think we have got to look a little bit deeper than face value.

CJ: And this is the real problem we have – no, the real problem you [manufacturers] have - because if you send us literature that is going to offer this, that and that and the collateral party is ‘AA’, great, we send it out, and then suddenly they become ‘A’ rated. Do you pull the product?

MO: Yes we have. In one scenario we had one investment bank with certain parties where, when it changed from ‘AA’ to ‘A’, they were not comfortable with it. So, we changed the product, and put another bank in, which they were comfortable with. We are talking about 'am I comfortable with a ‘BBB’' or ‘AA’? And in many examples one might argue whether it is strictly relevant.

When somebody is actually trying to get money out of the retail space and they are paying over the odds for that money, you know at that time that that bank really is desperately in need of money. If it is desperately in need of money, why do I want to do a structured product with those guys? It just doesn’t feel right. I can say ‘ok, great product, 15% margin in it’, but that is just horrendous. What are you going to give the client?

Yes I know everything is widened, but it comes back down to whether the client is reasonably happy with the markets. Are they reasonably happy with some names that they might know, and where the government has stepped in and they feel reasonably comfortable because the banking system is not going to fall down now? As it stands today if you turn around to somebody and say: 'It could be a JP Morgan, Citigroup, or Investec,' are they  reasonably comfortable with these guys?

If somebody puts all their money in one product, then that is really worrying. That is something that can go horribly wrong because if you put all your life savings in one product, which is what is happening in Germany, well that is a world that we don’t deal in. Luckily, we have got advisors that don’t stick all of the client’s money into one product. They spread it around and they are sensible.

RS: I think it is important to distinguish between intermediate related sales and direct sales. I completely agree that IFAs are very far from being dumb here and they will ask the right questions. I am quite comfortable with people like Colin looking at all the products on behalf of their clients and taking a view. Where I get less comfortable is where they are sold through the bank branches and this is what involved the precipice bonds. That was the really big scandal, when counter clerks were representing these things effectively as a high interest bank account. The business rules around banks are simply not strong enough, in my view, to support the sales around these products.

GD: I think the banking distribution network is still huge. The likes of Santander, which bought the Abbey - and there are many many others like it - distribute hundreds of millions of pounds of, in my opinion, inferior product - inferior to the IFA sector that is. Now, when you take into account that the IFA sector products also generate commission for the adviser, even after those fee payments have been made, the products are still more competitive than many products issued by banks and building societies direct.

So, the question that has to be met is: is there enough investor education available, is there enough information that they can access to help them make a genuinely objective decision? I think the answer to that is no. I would be surprised if anyone disagrees with that comment. It is a captive market. When a client walks into a bank and they have been going there twice a week for the last twenty five years, and the clerk or the direct tied sales agent recommends that they move £40,000 from a high interest account to a guaranteed income product, then nine times out of ten they are going to do it. They are going to move it because they don’t know any different.

All that can happen is that the industry can educate advisors and help them educate clients because at the moment the problems are self-perpetuating. An example I would give is in the offshore investment world.  From my contacts there [I understand that] these companies are writing £150m a month or more, and it is all going into Irish banks because it is guaranteed.

Now, if the problem in Ireland is that they now have a fiscal debt in excess of twice national GDP, these providers have a responsibility to the industry to help try and eradicate this problem. But, while the industry exists in its current format and the margin can be made on product with a guaranteed cash fund they will continue to do it. And that is not going to go away on its own. It is just perpetuating a problem that is only going to get worse, which affects all of us around this table.

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