Structured products have enjoyed mixed fortunes over the past two decades; the author of this article considers what can be done to make the market more mainstream.

A part of the wealth management toolbox is the structured product. The sector waxes and wanes: it was hit hard in the 2008 financial crash (firms such as Lehman Brothers were large players in writing these entities). They seek to give users access to asset classes within certain pre-set constraints, such as upside exposure with controls to cap capital losses, and so forth. Using instruments such as options and futures, the language of structured products can be daunting to the uninitiated. 

So where do structured products sit today and why haven’t they attracted a more mainstream audience? To try and answer some of these points is David Wood, managing director of international business at Luma, a platform for structured products and other entities. 

The editors are pleased to share these ideas and invite readers to jump into the conversation. The usual editorial disclaimers apply; email tom.burroughes@wealthbriefing.com

A decade ago, the structured product sector was beset by problems. Regulators in the US and UK had providers in their sights for governance failures, resulting in fines, while the low interest rate environment threatened their ability to build products with attractive returns.

What ultimately resulted from that period, in the wake of the global financial crisis and Lehman Brothers bankruptcy, was a significantly changed regulatory environment that fundamentally altered the structured product sector. The introduction of MIFID II and PRIIPs [Packaged retail investment and insurance products] regulations had a profound impact on the way products are designed and sold.

Perhaps the most consequential outcome of these rules has been that suitability of product has been placed front and centre, both in terms of manufacturing and distribution. Where regulatory scrutiny once fell on the lack of a needs-based approach to product design and sale, that has become a thing of the past, with providers and distributors duty-bound to ensure and subsequently prove that a product is right for the investor. As a result, we no longer see the type of regulatory enforcement action that blighted the early 2010s.   

The other major benefit has been better education. Whereas headline rates and returns were once the overwhelming focus of attention, advisors and their clients now have a very clear understanding of all the relevant elements of a product. Credit risk, for one, is now widely understood in all its forms (albeit the demise of Lehman also provided a brutal lesson in its importance). But other risks, such as leverage and liquidity risk, are equally well understood today. Regulation has played a large role in moving the industry to a much better place here.

Not all plain sailing
While regulation has been broadly positive for structured products, there are notable exceptions. In the UK, the Retail Distribution Review [of 2013] has had a major impact on the wealth market for structured products, impacting volumes over the past decade compared with European countries. 

Comparable data across countries is difficult to collect, but a European Securities and Markets Authority (ESMA) market report showed that France’s Structured Product volume alone was over four times the size of the UK, leaving the UK with the smallest market of any major EU country. Preventing fees being taken from products led a lot of firms to focus on other asset classes, which effectively restricted structured products to highly advised or high net worth investors. 

Where structured products continue to be supported more widely by firms, the offering is typically vanilla, tracking a range of major indices. While there is nothing wrong with that, it leaves no room for products to be tailored to mass affluent individuals, something that has become a major selling point of the asset class in other markets. 

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Low-rate environment 
If certain regions have been impacted by regulation more than others, one unifying theme has been that structured products, rather than being crushed by ultra-low interest rates, have adapted to fulfil a need for alternative sources of yield. While yield enhancement products like autocallables were once seen as exotic and niche, they have become mainstream. Indeed, their combination of yield uplift and capital protection has proved so popular that this structure now dominates everything else. And few could argue that they have not performed well: 

StructuredProductReview.com (1) recently reported that in the UK market 91 per cent of products maturing in 2021 generated positive returns for investors over the term, and despite the turmoil of the pandemic, capital at risk products generated an average 6.82 per cent per annum during their life.

Nonetheless, the rising rate environment gives providers and wealth managers far more scope to create interesting structures – those with, for instance, full capital protection – that could appeal to different types of investors. It could also reduce the complexity as higher rates facilitate higher returns without the need to create more complicated, multi-basket structures. It could even see the return of structured deposits in greater numbers, which effectively have guarantees through deposit protection schemes. But for the benefits of these types of structures to be widely felt, accessibility will need to improve.

Going forward
The fact that products change over time only serves to reinforce the fact that they are both complex and ill-suited to the standard equity or fund systems that are used to manage portfolios. Even where systems can manage bonds, they are typically unable to cope with structured products, which have a number of variables and events over the lifetime of a product.

These administrative challenges have clearly proved a major barrier to adoption, as many firms have simply found is easier to overlook the asset class than try to create the controls that ensure the right products are sold to the right investors – while evidencing that they have done so. That is challenging to do at scale.

Given this, the key to greater adoption, in our view, is technology. Wealth managers are not going to embark on a major tech build to accommodate one asset class, but if structured products can be integrated into the legacy systems they already use, they are far more likely to incorporate them into their clients’ portfolios. As wealth managers become increasingly familiar with the products – and there is no lack of educational and training content available today – they can be treated like any other asset class, bringing a more defined outcome and principal protection to a wider investment portfolio. 

It is early days, but this journey has begun. The gloom that hovered over the sector for years has lifted as regulation and investment have ensured that products are suitable, fit for purpose, fully understood and transparently presented. Few asset classes can match their record of preserving capital. Structured products have proved that they deserve a place in portfolios – now we need to improve their accessibility.

 

Footnote
1,  Structured Products Annual Performance Review 2022 – StructuredProductReview.com