The Swiss Structured Products Association and Scoach, the Swiss exchange for structured products, plans to launch a facility that will minimise issuer risk by means of collateral security, coming in the wake of shocks such as the bankruptcy last year of Lehman Brothers.

The new service will be offered by SIX Swiss Exchange and is based on the securities lending infrastructure of SIX SIS and Eurex Zurich. Collateral security functions via a collateralisation mechanism which creates an impartial valuation of an individual structured product, independent of the issuer. The launch is planned for early in the second quarter of 2009.

The development comes at a time when there has been intensifying focus on the counter-party risks associated with structured products following the collapse last autumn of Lehman Brothers and the US state bailout of US insurance group AIG.

From the Swiss legal viewpoint, structured products are akin to bearer bonds. As such, investors in structured products bear a default risk that depends on the creditworthiness of the issuer.

The proposed system will offer the chance to reduce this issuer default risk. It involves the issuer depositing liquid securities as collateral with SIX Swiss Exchange. The market risks - other than default risk - associated with a structured products are not affected by this collateral, and these remain in full with the investor.

The collateral-secured option is to be offered for structured products listed on SIX Swiss Exchange and traded via Scoach. Collateral will be calculated according to the nature of the structured product in question. It will be determined individually for each product and will normally remain unchanged for the term of the product. However, the issuer may be required to supply an amount of additional collateral if there is a significant price movement that increases the risk of default.

If an issuer can no longer provide sufficient collateral for its structured product at the current market value, the securities that have been deposited previously serve as realisable surety in favour of the investors.

"With this innovative system of collateral security, we are joining forces with Scoach Switzerland and the SSPA to make a major contribution to strengthening the structured products market in Switzerland," said Christoph Bigger, CEO of SIX Swiss Exchange, in a joint statement issued by Scoach and the SSPA.

The SSPA will introduce a risk classification system in the first half of this year. "Risk classifications for structured products will mean that the SSPA can achieve one of its key objectives. They will enable investors to benefit to an even greater degree from the advantages offered by structured products", said Roger Studer, president of the SSPA in the statement.

The European industry association – now operating under the name of EUSIPA (European Structured Investment Products Association) – has decided to adopt large parts of the SSPA classification model.

Eric Wasescha, executive director of the SSPA, said: "This is a huge success for us, as it means that a common classification system can establish itself as the standard throughout Europe."

The model introduces a distinction between non-geared products and leveraged products for the first time. It will also detail product sub-categories.

Given the experience of clients whose structured products were issued by Lehman Brothers, for example, this move to greater transparency and security is to be welcomed, even though it will increase the costs of structuring products and therefore the ultimate return to investors. It is not, however, obligatory for a product to make use of this facility so investors will have the choice between reducing default risks or increasing potential returns.