“Equity-linked notes are a type of structured product issued by brokerage firms and traded in the secondary markets like shares of common stock,” the report notes. “Once sold only to sophisticated investors, structured products are increasingly being sold to unsophisticated retail investors. Equity-linked notes are difficult to evaluate and monitor, have high hidden costs and are illiquid. They are therefore virtually never suitable for unsophisticated investors.”

Using three examples of actual products sold by major brokerage firms to retail investors, Dr. Craig McCann and Dr. Dengpan Luo of SLCG go on to demonstrate that “investors who buy these notes at the initial offering dramatically overpaid for the investments.”

It all sounds rather exciting. In fact, the report sounds groundbreaking and structured products professionals everywhere should be quaking in their boots.

Fear not though since the basic premise of the report is inherently flawed. SLCG takes an entirely US centric view, ignoring the fact that European and Asian investors have been buying equity linked notes for a good few years. If the report had been titled ‘Are Structured Products Suitable for US Retail Investors’ I would have been less quick to judge. But the report doesn’t state it is only examining the US experience.

Ignoring this oversight by SLCG, is it fair to suggest that structured products are not fit for US retail investors? For one I don’t think so: this may have been the view of US retail investors a few years ago but things have changed dramatically in the interim. Also someone in the country must be buying them, and, by association understanding them, if market figures are to be believed.

The New York-based Structured Products Association (SPA) is preparing its final assessment of the business year and predicts that the US structured products market will be worth around $70 billion by the end of 2006, up from $48.7 billion at the end of 2005.

To my knowledge there have been no SEC registered complaints from US retail investors saying they are baffled by the intricacies of equity-linked notes. And there has certainly never been a retail structured products mis-selling scandal in the land of opportunity. Importantly, SLGC only examines equity-linked products, although the title of the report would suggest it seeks to analyse the risks and benefits of all forms of structured products.

What’s more, the report, while pertaining to be an academic study (written by PhDs and filled with graphs), makes the unforgivable mistake of quoting a largely one-sided source. Amazingly the very first citation of the report refers to a Wall Street Journal article which appeared early this month (click here for full story). The article was widely lambasted by structured products professionals worldwide for providing a one sided, and questionable, view.

I could pick more holes in the report but am aware that the readers of this site are more than capable of making their own conclusions. To read the SLGC report click here.

Open architecture has been the buzz phrase of the structured products markets for at least the past year. In a climate of open architecture private banks want access to as many online prices as possible – not just the online prices of one bank. They don’t want to have to run all the online platform as doing so will make their lives harder, not easier. Considering this isn’t it time the structurers came together and developed an online platform offering prices by multiple banks?

We will explore these issues in the February issue of Structured Products magazine. In the meantime if you have any thoughts, or know of any plans to develop a one size fits all online trading platform, do let me know.

In a letter to the newspaper MS, from Gloucestershire, explained how he or she (it’s difficult to tell from the initials) invested a £9,037 maturing Tessa in a Global Titans Tessa plan. Five years on he or she has got back “the same £9,037 despite a big bounce back in share prices over that time.” MS wrote that “the plan is now administered by TD Waterhouse but no one there is able to explain this dreadful performance.”

Levene explained to the investor that the plan, which was sold by DLJdirect (now part of TD Waterhouse) and manufactured by Credit Suisse, comprised of five baskets of 10 stocks. “It only took one stock in each basket during the last year of the plan to be 33% or more below its starting price to trigger a “safety breach” and wipe out your profit on that basket. And at least one stock in each basket did so,” Levene told the complainant.

Why TD Waterhouse is allegedly unable to explain this is a mystery. And if this is the case then MS has every right to feel aggrieved. But should MS really be so surprised at the outcome of the plan?

Levene goes on to say that “if advisers failed to point out these substantial risks, consider a complaint.”

Nowhere in the letter has MS said that he or she was mis-sold the plan or even suggested that the risks were not explained. Also suggesting that TD Waterhouse can’t allegedly explain how the plan worked because “perhaps no one understood how it works” borders on libellous according my journalistic training. (Note my use of the word ‘allegedly’ throughout this article: after all MS could be anyone with an axe to grind, and we can’t really trust what they write, especially considering their desire for anonymity).

From the facts at hand I can divulge this: MS wrote the letter to The Guardian, and can therefore read. If MS can read he or she probably should have read the accompanying documents that explained the risks of the investment. Also, I assume that Levene was not present when MS decided to invest in the plan and therefore probably shouldn’t end his response with “consider a complaint” as he really doesn’t have access to all the facts. He should also probably avoid saying that TD Waterhouse staff are perhaps unable to understand how the plan worked.

I have never worked as a financial ‘agony uncle.’ But from the facts I have at hand I can see that nothing is simple in the world of consumer champions.

During a recent debate in the Singapore Parliament on ways to enhance the country’s standing as a financial hub, Member of Parliament for West Coast GRC, Ho Geok Choo, voiced concerns about the way banks target customers with deposits of a certain size for structured products.

"In the case of structured deposits or investment products, customers are not made aware of the many and often substantial hidden costs in these products,” she said according to various reports in the Asian financial press. “While they're promised protection of their principal sums, many of the management controls of these products are often deducted upfront so in cases where the returns on these products are minimal, depositors may actually lose part of their principal.”

Banks must have greater transparency by advising their customers of the hidden costs of these products, the MP went on to say. “A related area of concern is the way banks target specific customers with deposits of a certain size; this clearly violates the privacy of the customer. Banks have obviously made use of privileged customer information to target their customers for cross-selling. Do customers have any safeguards to protect their information?"

It’s a valid point and one that the Monetary Authority of Singapore (MAS) responded to. According to the financial regulator strict rules on cross-selling by banks under the Financial Advisor Act are already in place.

That may be the case, but isn’t it worrying for the country’s structured products professionals that their industry is being debated at such a high level?

As I’ve said in previous editorials - regulatory, or indeed parliamentary, probes show one thing: the industry should come together take proactive, rather than reactive, steps to explain itself, and protect itself.

It’s hardly surprising that one of the five was in fact a West LB product, its Capital Protected Income Plan. But treating the email as thoughtful analysis, rather than product promotion masquerading as market data, I have to admit that I have, perhaps for the first time in my career as a journalist, appreciated an email from the flacks.

“Investors [in the UK] have little choice when it comes to structured products if they want income without fear of losing their capital,” West LB’s London-based head of structured products, Maurice Wren, was quoted in the email. “Despite the recent base rate rises [by the Bank of England], interest rates remain historically very low, and we are seeing a demand for a wider range of income producing, capital safe products.”

One of the reasons that lenders are dragging their feet, argues Wren, is that income plans are inherently more complex to structure and manufacture than their growth counterparts. “They require much more than simply buying a FTSE 100 call, and lenders seem to be put off by the greater complexity involved in getting the product specification right,” he says.

Of course, Wren is not the only person to criticise the UK markets plain vanilla offering and it is true that the UK market lags behind many other European markets in areas of innovation. Given the majority of the structuring houses have major bases, if not their head office, in London, the lack of innovation in the UK market is an anomaly.

The email got me thinking: are the 627 offerings in the UK driven by investor demand for simple growth structures or are the distributors not offering investors the right products? Are distributors missing out a trick by not offering income products?

I then also remembered that we covered some of these thoughts back in July 2006 (click here), not that I’m indulging in product promotion. But my point stands: finally a PR firm which knows how to write a press release.

Daniel Sheehan, Staff Writer, Structured Products

“The UK and France in particular have well-established structured equity derivatives businesses that benefit from significant retail distribution,” the report notes. “Looking at the mix of business between flow and structured derivatives, Europe has a greater lead over the United States in the structured derivatives revenue market (60% versus 25%) than it does in flow derivatives (52% versus 32%). These revenue pools are likely to grow rapidly given the underlying market growth, with Europe the main beneficiary as London solidifies its position as the center for derivatives trading.”

Maybe so, but the report neglects that the US is arguably one of the fastest growing markets for structured products in the developed world. According to figures from the Structured Products Association, sales for structured products in the US stood at $48.7 billion at the end of 2005 and now they are hovering around $70 billion mark. That’s an impressive growth rate.

Perhaps the biggest challenge for maintaining the US position as a center of financial innovation is educating retail investors about the benefits of derivatives-based investments. If these figures are anything to go by the process is already underway.

In the October 2006 issue of Structured Products magazine we profiled Yasaar Limited, a UK-incorporated company offering sharia compliance and co-ordination services. I have asked DIB if it can still claim to be the world’s first such company and am awaiting a response.

To be honest I’m not too fussed who has the first mover advantage. Rather the press release demonstrates increased competition in the field of sharia compliance. Banks are launching sharia departments and specialist companies, like the one due to be launched by DIB, are becoming more commonplace.

In the January issue of Structured Products magazine we ask David Kemp, Zurich-based director in the UBS Islamic Finance Group, about what 2007 may hold for sharia compliance. He forecasts the market will grow up to 20% in 2007, up from $500 billion today.

I’m sure many will claim to be the first to achieve something in the market, and I look forward to covering these developments as they happen.

The CSA says it officially views PPNs linked to hedge funds as an “area of concern.” In fact “registrants selling PPNs may not be meeting their know your client (KYC) and suitability obligations” according to CSA Staff Notice 81-316 Hedge Funds, a sample-based review of hedge funds in Canada. If this is the case why is nobody acting? If issuers really are ignoring KYC rules then action is urgently needed now.

On the one hand CSA says it is concerned and hints at new rules; on the other hand it has failed to act after almost six months of ‘consultations.’

A few of my contacts have openly laughed at what they call “empty threats of tighter regulation.” The CSA concerns and sporadic papers are simply a reaction to the Portus scandal which occurred almost two years ago (click here for an article on the Portus debacle), they say. PPNs are selling well and there have been no investor complaints, they add.

Do you think the CSA will actually act on its concerns? Have other regulators examined the marketing of hedge fund-linked products for as long as the CSA? Let me know…

He pointed out that in theory lottery players could be offered a “free” lotto by any bank via its ATMs. It would work like this: every time the customer withdraws some cash, he’s also offered the chance to deposit, say, £100 into his lottery account. For that, he would get 100 plays on the lottery organized by the bank, with breathtaking prizes of millions each week.

The big difference between this and the state-sponsored lotteries that it would compete with would be that the player could be guaranteed by the bank to get the full £100 back at the end of his 100 plays – or he could pull the £100 out of the game at any time if he was short of cash. The 100% cash-back guarantee and the lottery prizes are, of course, funded by the interest the bank can generate from the £100 (or rather hundreds of thousands of £100s) while it has it on deposit.

Equally, it’s also true that this is not a “free” lottery at all – there’s inflation risk as well as the larger opportunity cost of leaving your money in a non-interest bearing deposit to play the lottery. But if the prizes are assumed to be the same, it is a lot better deal in purely financial terms than any lottery I’ve come across. So why haven’t banks actually launched such lotteries? After all, they’re trying to sell plenty of other products and services via their cash machines.

Samaria told the audience at our conference that he believes that, in Italy at least, nobody would trust a bank to run a lottery without fixing it. However, there’s no doubt that reputational risk would be involved and most banks would be careful about inviting customers to gamble, even if they got their money back. And let’s not forget the billions that state-run lotteries generate for charities and public causes. What bank chairman would want to be seen to be diverting some of that money to his trading account?

Maybe I’ve missed something, though, and someone has seen something similar put into practice? Let me know …

Structured Notes provides a new way for the magazine's journalists to analyse news. It's all about editorial analysis and commentary. And it's all about giving you the right to reply. At the bottom of every entry you have the chance to have your say.

Our webcast section, meanwhile, provides market participants with a chance to view their peers speaking at our conferences. So far we have added 16 sessions, all fimed at the Structured Products Europe event late last year. Click here to watch one of the sessions, and look out for other webcast additions in the next few months.

I hope you enjoy our updated web content and if you have any suggestions, or questions, do get in contact with me through the comment section.

Paul Lyon
Editor
Structured Products

The European Retail Structured Investment Products Market 2006/2007, published by our books division, Risk Books, provides detailed analysis for 17 distinct structured products markets.

Below are a few sample findings.

"The report found that, between 2005 and 2006, the UK structured products market shrunk by approximately 11% - surprising many analyst expectations - whereas other European markets generally experienced impressive growth. The French market, for example, was reported to increase from €15.5bn in 2005 to €18.6bn in 2006. The Italian market, however, remained largely stagnant at approx €20bn, due to regulatory confusion holding back product development. The report also demonstrates that newly developing markets for derivatives-based investments show great potential for 2007, with the Polish market up from €450m in 2005 to approx €630m today, for example.

Equity related products make up around 60% of retail structured products offerings across Europe, but the report shows that commodity-linked products and FX linked investments are also on the rise. Meanwhile, the report found that structured products professionals are still struggling to come to grips with regulations such MiFID."

Click here for more info on the report.

But is it really an example of open architecture? Surely the whole point of open architecture is NOT to tie yourself to just one instituion. Also, as a few of my contacts have noted, where is the sense of tying your future to just one structurer - even if it does happen to be one of the best known names in the market?

Any thoughts appreciated...

The exchange will now initially be called Börse Frankfurt Smart Trading in the German market and SWX Quotematch in Switzerland. The lengthy names, which are temporary, hardly trickle off the tongue. By operating under different names in different markets it will be difficult for the partnership to achieve its goal of becoming a true pan-European venture as initially planned.

In December, the exchange’s chief executive, Marc Zahn, told Structured Products that Alex will "generate significantly higher Europe-wide growth potential for this segment than would have been possible alone." However, for now, the Swiss Exchange and Deutsche Börse are indeed going alone – in name at least – effectively putting European wide plans on the backburner while the legal wrangling is sorted out.

No doubt the joint venture will be looking for a speedy resolution to the costly dispute through a joint new name or a return to Alex.

In better news for the exchange, structured products trading did begin as planned when markets opened for the New Year and the trading is aggregated in all bar name.

Daniel Sheehan, staff writer, Structured Products