The structured products market has been on a roller-coaster since the bankruptcy of Lehman Brothers reminded investors of the vital importance of understanding counterparty risk. Credit Suisse takes a look at some of the main issues in this sector.

Rory Codd, of Credit Suisse’s private banking intermediaries team, outlines some of the questions and answers in the ever-shifting structured products sector.

What are the main advantages of a Structured Product?

The core advantage for structured products over any other product is their flexibility. It is important to understand that they are not an asset class unto themselves but simply a way of gaining exposure to a specific risk whether that be currencies, equities, commodities, etc. A structured product enables an investor to gain exposure to that risk in many more ways. For example the vast majority of structured products available today will have the FTSE-100 as their underlying, however they will offer exposure to this equity class in many different ways: Capital Protected, partially protected, call spreads capping upsides but increasing returns for smaller movements, auto callable products giving defined returns. Investors are able to have far more choice in how they invest into an asset class.

Capital Protection is seen as a key advantage for many investors, but how protected is an investor's capital?

The capital protection of any product is only as safe as the bank or building society providing the protection. An investor's money sits on a bank's balance sheet for the life of the investment. Often that bank is the same bank that sells the structured product to the end investor but the vendor can be different to the provider of protection so investors should understand which institution is underwriting their investment. As long as the provider of the protection is operating normally when the product matures the protection will stand.

For any investor it is critical that they are aware of who is providing the credit risk side of their investment. It is clear that the majority of investors in structured products still look at the returns on offer which can lead to an under appreciation of what the potential risks are of their investment. Two products can offer 100 per cent protection on maturity, have the same underlying asset and the same structure with very different returns. Naturally investors will go for the greater returns without perhaps understanding why they differ.

All other things being equal it is likely that the higher risk product holds a higher counterparty risk and in turn generates higher returns.

How has the Structured Product industry performed given the financial crisis of the past couple of years?

The structured products industry has emerged from the financial crisis in an arguably stronger position.  During the last bull market, from 2002-07, the total issuance of products into the UK remained reasonably stable with between £5-7 billion being issued each year. 2008 saw a significant increase in amount of issuance and this continued into 2009.

We believe this to be a function of a number of things: Firstly, prior to the fall in markets, investors had been happy to continue to just be long in most asset classes. The protection and defined returns of a lot of structured products did not appeal.  Secondly, the rapid fall in markets through 2008 meant that investors were reminded of the flexibility of structured products and their ability to extrapolate returns in a variety of market conditions. Lastly, we believe that the general awareness and understanding of the uses of structured products has led to more confidence around the instrument as a tool for making investments.

What is the outlook for the Structured Products industry this year? 

Increasing confidence in structured products due to greater understanding of the product. However, providers in the UK, such as Credit Suisse, need to continue to provide an education to investors to maintain momentum. We also expect to see a subtle change in focus away from educating IFA’s and brokers towards providers assisting with end client education. Proper support to the advisors in how to educate their clients, aligned with quality products and supporting collateral will enable the industry to continue to develop that important confidence around the use of structured products. We also see continued development in the style of products available. Historically, the structures offered by all providers in the UK have been typically quite standard, with the predominant underlying being the FTSE 100.

We expect structures and underlying assets will evolve and develop and investors will look to use structured products to access other asset classes: Currencies or emerging market equities for example.

Finally, with no increase in rates in the foreseeable future and with many market commentators struggling to see growth outside of emerging markets, we think that the flexibility of structured products will enable the providers to offer investors some real alternatives to extrapolate above inflation returns across a variety of asset classes.

Rory Codd joined Credit Suisse’s UK private banking intermediaries team in 2009 to supply institutional structured products to IFA’s and retail distributors utilising the intermediary network offered by the bank’s wealth management business. 

He previously established and managed a structured derivative desk within Credit Suisse’s investment banking business. Prior to joining Credit Suisse in 2007, he worked in the UK Structured Derivatives team at Merrill Lynch International, providing structured solutions to private clients and private banks.