Irish providers try to get the better of deposits

Investors in Ireland are naturally risk averse and as eager as any for transparency and liquidity, although still in need of the safety that deposit accounts bring. The development of a secondary market is a crucial element of the change, but it will take time. Clare Dickinson reports from the Structured Products Ireland conference held in Dublin on September 16 2010

Mark Caffrey, Ulster Bank

Deposit products are hugely popular in Ireland – and with blanket cover for all deposits under the government’s Deposit Guarantee Scheme (DGS) and a high, tax-free interest rate offered by the post office, why would anyone want a note-based investment product? For issuers trying to entice investors away from deposits, the development of a secondary market is important, but providers remain wary.

The Irish structured products market is doing better than expected. In his opening address to the Structured Products Ireland conference held in Dublin on September 16, Mark Caffrey, head of investment and funding solutions at Ulster Bank in Dublin, explained that the volume of outstanding products stands at €6.8 billion, with just over €1 billion added to that total this year. Throughout the day, delegates commented that this figure was higher than they had imagined.

But Caffrey warned those present to be prepared for the unforeseen, for what he called “the gorillas in the room”. He illustrated his point with a video clip of a group of people throwing a basketball. During the clip a gorilla walked into the group, but only around one-third of the attendees noticed it.

“There is no doubt the environment works well for us in selling capital-protected products, but it is difficult in terms of putting products together because there is movement in the market,” said Caffrey.

He continued his warning, saying, “Things out of our control threaten our business. We need optionality in the business to prepare for the gorillas we can’t see. What we can do is to think about our current strategy and products. Are we overdependent on the demand for capital-protected products continuing?”

The majority of the volume remains in deposit-based products, with some banks issuing only deposit structures. There is €100 billion on deposit in Ireland, Iain Cahill, director of Art of Wealth and Optima Strategies in Dublin, told the room during his afternoon presentation.

State guarantee

Last year the Irish government announced it would cover all retail and corporate deposits under the DGS. An Post, the Irish post office, is currently offering interest rates of 21% over five and a half years or 10% over three years. This is tax-free, covered by the DGS, and compares with a European Central Bank interest rate of 1%.

Ian Cooke, head of FBD Investment Services at FBD Life in Dublin explained: “The person who just put money on deposit is the happiest at the moment, so it is hard to sell structured products. The client doesn’t always realise you are trying to help him.”

Given the high rates offered by the post office, it will take a lot for anyone to be persuaded to invest in structured products – which cannot offer such enticing rates, incurs taxes and are not state-guaranteed.

Duggan Asset Management has come up with a solution, as Mark Tully, Dublin-based investment analyst for the company, explained. It looked to Japan, which has an interest rate of 0.1%, as a model, and came up with a split-deposit bond that puts part of the investment into a bond and the rest into an index tracker.

The Irish government’s DGS ends in December 2010 but is extended until 2015 for fixed-term products. Responding to a question, Cooke said that investors are only concerned about the DGS, and not about counterparty risk.

He also said that it is difficult to monitor products after their strike date, and after his presentation went on to say that an index-based product is easy to track, but if the product is based on a basket of single stocks, investors want information from the issuers. The more information there is available, the easier it is for the sales teams to market the product.

“A decline in the [post office’s] artificially high interest rate compared with the ECB rate, and more positive sentiment” is what it will take to get investors out of deposits, he added.

Deposits have their limits, explained Caffrey during an interview on the sidelines of the conference. “In every market that is risk-averse, moving out of deposits is a big thing. As risk appetite returns, investors will want other things, such as autocallable payment styles. The regulator would have problems with doing certain payouts as a deposit.”

Slipping into secondary

One of the points highlighted throughout the day was the need for a secondary market, which would offer one way of giving investors the confidence to move out of deposits.

Peter Leahy, chairman for the day and head of financial training at Hoare Capital Markets in London, explained: “It seems to many people that the [UK’s] Retail Distribution Review [RDR] is likely to increase the impetus towards having a secondary market.

“It’s often difficult for advisers to contemplate a client selling back a structured product, because of the fees. If that is made transparent early on [as is the RDR’s goal] it is an incentive. It becomes more explicitly investment advice on an ongoing basis. A good adviser will approach a client and tell them that product has changed and it is not so appropriate.”

While no one is certain what effect the RDR will have on the Irish market, there was a sense that some of the changes being implemented in the UK structured products market may be adopted in Ireland. If so, this also increases the Irish market’s incentive to have a secondary market.

David O’Shea, Cork-based investment manager at Quintas Wealth Management, said that investors want a secondary market. Graham Fox, investment development manager at Irish Life in Dublin agreed. However, speakers and delegates alike seemed wary and uncertain about how to create such a market.

Ulster Bank has made a leap into the unknown by listing some of its products on the London Stock Exchange. “The idea that you can buy something and then ring your broker and sell it if it’s in-the-money is a powerful idea,” said Caffrey.

One of the products Ulster Bank has listed is the Gold Bullion Euro Hedged Tracker, which tracks the price of gold but is hedged to get rid of dollar exposure.

Access to these products is limited at present, said Caffrey, because they fall under the European Union’s Markets in Financial Instruments Directive (MiFID), which means they are classed as a complex product and cannot be traded by intermediaries. However, Ulster Bank is developing this business so that intermediaries can trade the products, which will encourage retail investors who trust their financial advisor more than a broker they do not know.

The merits and limitations of structured products, particularly in the wake of the collapse of Lehman Brothers, were discussed at the roundtable at the end of the day.

“Many structured products are created by whizz kids with PhDs who have never traded the market or seen liquidity disappear overnight,” said Ian Morley, chairman of Wentworth Hall Consultancy in London and moderator of the roundtable.

“They take the models to the regulator, who says, ‘That is great.’ Sub-prime built on something which had low probability of selling, so we had permission to trade it.” In the end it traded on a par with US treasuries, said Morley.

He went on to complain about the lack of regulation in Ireland: “The regulators got caught with their trousers down,” he said.

Yet again the words transparency and liquidity were thrown around, and from his position in the audience, Ulster Bank’s Caffrey noted that listed products have to go through the exchange’s listing process and are therefore regulated, but warned that “there will still be a black swan. No one predicted what happened two years ago.”

Listing products would give them the transparency that seems to be so important, and adding the opportunity to buy and sell a product during its lifetime would add much-needed liquidity.