Building in safety

The structured products market in Asia is almost unrecognisable from where it was 12 months ago. Products such as accumulators and range accrual notes have been consigned to history, while product manufacturers and distributors alike look for new ways and means that will cope with still turbulent markets. By Richard Jory

Asia's contingent of retail investors took their protests to the streets in Hong Kong a day before the start of Structured Products Asia 2008, and their concerns dominated the panel sessions and break-time conversation. "In the past, customers would only focus on the deal - they would not look at the credit risk," said Bruno Lee, head of wealth management at HSBC in Hong Kong, speaking on the morning panel of day one.

Fellow panellist Henry Pang, managing director, and head of equities and derivatives Asia (ex-Japan) at BNP Paribas in Hong Kong, added: "This is a confidence crisis - (getting over) credit ratings and the act of survival of issuers will take time. It is an image thing."

The solution is another layer of complexity - giving the investor an outline at least of what credit quality is and means - and even more training. Distributor budgets already heaving with the weight of training and marketing costs have a new element to cover: basic training in credit. "Structured products are not going to die," asserted Nicholas Leung, head of investment product support in the wealth management division of Bank of East Asia.

But the possibilities of bolstering beleaguered issuers are not obvious, according to the panel. Adding a credit default swap to the financial package that distributors are selling comes with a health warning now that newly bailed-out insurer AIG has been confirmed as a major part of this business. More obvious, perhaps, would be a move to introduce more supranational issuers such as Exportfinans, the Norwegian export credit agency, or even companies like Toyota. "But these would be European issuers in Asia," said BNP's Pang. "There is more exploring to do here."

Either way, "we need to make disclosure and transparency very simple," said HSBC's Lee.

Further answers included a renewed emphasis on diversifying credit risk, buying from 10 institutions rather than one, said Pang.

While regulators and distributors grapple with transparency, it is difficult to know how much investors understand. This question to the panel raised the prospect of distributors taking a greater degree of responsibility for the products they explain and, more importantly, sell. "The cost of such a third-party guarantee would add up to 1-5% to deal costs," said Leung.

HSBC's Lee made the observation that, "distributors are intermediaries, and they have a responsibility to screen a product".

Leung offered another option, suggesting that, as stock exchanges provide some comfort, the market should look to list more products, presumably alongside increased regulatory scrutiny. The response from the audience and fellow panel members was not supportive.

Lee declared he was against listing, as it would remove the financial engineering element of the business, which allows banks to tailor their products to specific needs. Furthermore, he noted that such an option would severely extend time to market. "Even if they were listed, look at Lehman warrants, they were listed," said Lee. "And there is still a lot of value in over-the-counter products."

Keith Styrcula, chairman and founder of the Structured Products Association in the US, endorsed the call for more transparency, particularly in price and secondary market liquidity. He also noted the complications more listing could bring, giving the example of BNP Paribas and Societe Generale, which do not have registered shelves from which they can do such business.

Noting the listing of sophisticated products in Frankfurt, Pang went on to point out that listing does not necessarily mean liquidity, bearing in mind listed products such as warrants are vulnerable to volatility. "Structured products are a single subscription product and they have a finite time horizon," said Pang. "Listing will only increase the cost."

A series of questions from the audience at the Island Shangri-la Hotel venue culminated in a reprimand to the banking industry, delivered from the floor by Shyan Yuan Lee, former commissioner of the Taiwan Financial Supervisory Commission and professor in the department and graduate institute of finance at National Taiwan University. "People buy very complicated products from a sales force driven by fees and bonuses," he said.

Pang responded by stressing the need for more dialogue and for the key jurisdictions to work together.

Lee had opened the conference as the first of two keynote speakers, addressing the changes in Taiwan - mainly aimed at tax changes for foreign investors - which have assisted the increase in the volume of structured products business transacted. An initiative, announced on August 14, to raise the profile of Taiwan as an Asia-Pacific financial centre included the reduction of income tax for foreigners to 20%. This followed the lifting, on July 31, of the ban on China Qualified Domestic Institutional Investors (QDIIs). Lee noted China QDII investment stood at US$1.125 trillion.

But he also warned of misselling. "Misselling and customer complaints might slash the sales of structured products," said Lee. And regulators will already have their hands full dealing with the US$1.5 billion of principal guaranteed product issued by Lehman Brothers that had been sold by China Trust.

Opportunities

While the structured products markets in Asia-Pacific reel, Rishi Kapur, managing director, client markets, at Swiss Re lauded the continuing success of the uncorrelated market for pension and insurance-linked products. Kapur estimated the market size at US$47 billion as of March 5. "There are a whole lot of underlyings investors can access, if they want to take risk," he said.

"This is one area truly not affected by what's going on in the financial markets - it is, at least, a good diversification area," said Kapur. "We do not have more earthquakes because there is a disruption of the equity markets." One Typhoon 8 warning posted in Hong Kong only hours after Kapur spoke offered a spoiler to the strength and validity of his assertion.

The structured products in the broader market being pointed towards investors suggest some might have developed a desire for even more risk, said Terence Goh, global head, structured products group, group wealth management at Standard Chartered. "Volatility spikes mean we are going back to basics, with the use of dual currency deposits, single underlying equity-linked notes or deposits, and single underlying credit-linked notes."

Dislocation opportunities exit in South Korea and Indonesia, said Goh. Others at the conference noted the same opportunities in India.

Taking on the weaknesses in the current market, Goh listed a series of observations and suggestions, including the rise of the exchange-traded market, taking away a lot of counterparty risk, and fee-based advisory assessed in relation to the benefits of incentive-based rewards for frontline sales, recommending the system introduced in Australia. "Back-end or success fees for distribution for manufacturers on call-backs and positive payouts (could work more effectively)," he said.

Goh also suggested accrual fee structures against the up-front fees model. "Now is the time to reset the numbers and align our interests," he said. "Crisis equals opportunities."

Speaking on the second day, Keith Noyes, regional director, Asia-Pacific, at the International Swaps and Derivatives Association, observed: "The best market practices fall by the wayside, sometimes." Offering the familiar example of the 80-year-old woman being sold a 10-year principal-protected product - in his version of the story, she lived in Taiwan - Noyes referred to the provocative nature of product naming, as well as "misbuying".

"In Taiwan, these products have names like 'The Fireball' and 'The Thunderball'," he said. "There have also been incidences of 'misbuying', although this word is not in the English dictionary." An example of 'misbuying' came during the rapid sale last year of accumulators, when investors told brokers: 'My friend made a lot of money on accumulators so buy it.'

Despite this, Todd James, senior director and head of the investment advisory group at HSBC, later outlined the potential next step for structured products. "We continue to look for flow products that are easy to understand, and might be just on indexes or exchange-traded funds," he said. "We are providing more products with built-in safety features - we need to build floors into them so there is downside protection. And we are preaching the segmentation of clients, between those worth US$2-10 million and those with US$20-100 million: they have a difference in wealth as well as risk appetite."

"We are not asking enough questions," said James. "There needs to be more work done on what questions we ask up front."