Published November 10, 2009

Chasing away the ghosts of Lehman

Structured products are back but they've changed

By GENEVIEVE CUA

	Email this article
	Print article
	Feedback

(SINGAPORE) The failure of Lehman Brothers gave structured products a bad name but wealthy investors are warming to derivative-based solutions again. But events of the past year have left their mark on such products as structures are now simpler and tenors shorter.

'Clients are bringing their entire portfolio to banks and saying - help me to understand the good and bad risks. Help me to get rid of the bad risk.' - Anurag Mahesh, Deutsche Bank

Barclays Capital's head of investor solutions Philippe El-Asmar says issuance in the second quarter spiked, with volumes reminiscent of the market's heyday in 2007.

Overall, however, structured products issuance globally remains 20 to 25 per cent lower than 2008, which had in turn shrunk by 10 to 15 per cent compared to the peak of 2007.

The Singapore market in particular dropped as much as 50 per cent in 2009, as investors' relatively higher exposure to equities and leverage took their toll.

'We believe the market will recover slowly and there will be a regaining of interest in structured investments... More and more they are a tool to access markets and express a customised view,' he said.

Andrew Williamson, UBS head of investment products (Asia-Pacific), said: 'There is clearly renewed activity in the market, with some key differences. Those differences can be attributed to the events of the credit crisis, culminating in the collapse of Lehman, which introduced a higher level of investor risk aversion when considering counterparty exposure.

'The third quarter volume was a little lower than Q2, reflective of the moves we have seen in markets. But it's still at a level that I would consider very reasonable and a good sign that investors are willing to participate in markets.'

Figures on the size of the structured products market are difficult to come by as the bulk of structures sold by private banks are unlisted and packaged in a note wrapper rather than a fund. Market estimates of the size of 2007 issuance in the Asia-Pacific ranged from US$250 billion to US$300 billion.

The SRP Magazine, published by StructuredRetailProducts.com estimates global gross sales or issuance of structured products in the current year to end-September at US$225 billion. Asia's share of this was estimated at US$56 billion. The publication's data, however, excludes private bank products and is thus likely to significantly underestimate the total volume.

Its latest estimate for Asia-Pacific is US$66.5 billion in issuance, a steep drop from last year's total issuance in the region of US$129 billion.

In keeping with a more moderate risk appetite, clients are gravitating towards simpler structures with shorter tenors, picking transparent underlyings such as equity indices. This is in marked in contrast to 2006 and 2007, when tenors could be as long as 10 to 15 years and structures were complex and exotic.

Yet another difference is that Asian issuance has become more balanced, said Mr El-Asmar. Equity-linked structures had accounted for as much as 80 per cent of the volume in 2007. Equity's share is likely to have dropped substantially, and underlying exposures have diversified to other risk assets including credit, interest rates, foreign exchange and commodities.

'There has been a shift in structures, but not particularly in the way risk is priced. Long dated structures have inherently more risk, as the short end of the curve is more liquid than the long end. Just having the maturity shifting is one element of risk reduction.

'The other aspect is the return to simplicity, such as a single index-linked structure. The structures have risks that are easier to hedge rather than a 15-year correlation trade where you can't find a hedge in the market.'

Deutsche Bank's head of global investment solutions (Asia-Pacific) Anurag Mahesh says another key difference is that wealthy clients now tend to view structures in the context of their portfolios as a means to hedge risks.

'The industry has changed in a very fundamental way... Clients are bringing their entire portfolio to banks and saying - help me to understand the good and bad risks. Help me to get rid of the bad risk. The right risk is assumed cheaply. Wrong risk is expensive and people use structured products to get rid of that.'

Meanwhile Mr El-Asmar said the number of banks active in the structured products space has just about halved. 'There are fewer players this year and activity has concentrated on banks perceived as more credit worthy. While the overall market has shrunk by 25 per cent, there were fewer players. So some banks maintained their volume with a bigger piece of a smaller pie.'

Barclays itself saw its market share increase by 'several percentage points depending on the region', he added. Through the crisis, Barclays' online tool for clients has provided liquidity and pricing for all unlisted products.

Following Lehman's collapse, the biggest concern among bankers and their clients was counterparty risk, and there was a lot of discussion on the use of fund wrappers. Funds have some measure of protection as the UCITS III framework in Europe limits counterparty risk exposure to 10 per cent. Note wrappers, however, remain the preferred vehicle.