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“Trust me, I’m a structured product provider”

Financial crises teach a lot of hard lessons – lessons in greed, lessons in fear, lessons about calling markets, about overborrowing, about not relying on other parties beyond what it says in the contract, about not relying solely on ratings agencies.

Most people in financial services are doing a pretty good impression of having learned something, apart from maybe a few of the more unrealistic bonus boys and, I would argue, some of the smaller structured product providers.

In the case of the structured product providers, it now seems the FSA is going to take it upon itself to teach some lessons, judging by Dan Waters’ latest speech.

To quote that speech, Waters said: “We are keen to work through some of the purported regulatory blockages that stop investors or their advisers knowing which institution or institutions have issued the debt that makes up the capital protected element of a particular product.”

Those structured product providers who think that this is a mere aside should look up the definition of word “purported”.

The FSA is obviously going to look very hard at the justification used by many providers that European Union prospectus directive prevents full disclosure of the counterparty.

Even without Waters’ intervention, I must admit I have been totally baffled by the insistence from some providers that it is still ok not to disclose this information. The current crisis might as well have been designed to hammer home the lessons of counterparty risk.

I would hazard a guess that there won’t be an IFA out there who has previously sold a structured product affected by the Lehman Brothers’ collapse who does not now understand that risk.

We now know the failure of the counterparty spells very bad news for the investor and for the IFA who sets any store by their relationship with that investor.

But this bank bust isn’t an isolated incident. Several big American investment banks have narrowly avoided similar fates by selling up in a fire sale, even more of the UK banking sector may become state owned, the largest insurance company in the US owes its independent existence to the largesse of the American taxpayer. Indeed several countries are considered to be at risk of default.

These banks and this insurance firm didn’t fail but they very nearly did – more countries might – so the world may be running out of white knights in the form of either companies or countries.

It may be a statement of the blindingly obvious, but these are extremely risky times.

We also know we can’t rely on ratings, or at least, solely rely on them. They may work all things being equal – but things have not been equal.

As a predictive tool of the strength of financial institutions and in the face of a global meltdown on an epic scale, they have proved of limited use.

The former bank chiefs know this to their cost and admitted it to MPs in the last few weeks.

That is why I just cannot believe that structured product operators are still not fully disclosing the counterparty.

In this context, I do not think it is enough to say “we only use institutions above a certain rating”, nor indeed to suggest that IFAs who ring up can find out.

Clearly in the case of Lehmans, some investors got their fingers burnt knowing who the counterparty was, some not. But as I say, the risk should have been hammered home and now the need for as much transparency as conceivably possible should be a no brainer.

The retail providers affected by Lehmans should have this lesson seared on their corporate brains. These include NDFA, Meteor and Arc.

I find it almost unbelievable that in the last few months, these firms have continued to offer products to the retail market that do not say who the counterparty is.

An IFA or an investor wouldn’t be even able to do even a cursory Google search of the counterparty.

What if the counterparty blew up? Who is to blame?

I cannot but wonder if the adviser would have any defence when faced with a complaint at the ombudsman.

“Dear client, I advised you to take out this policy on the understanding that neither you nor I (unless I phoned) knew which financial institution provided the underlying insurance. The provider, which works out of a small office in the home counties has vouched for the firm, says it has a rating of xxx, and that is good enough for me. I am unable to say if the plan provider itself is rated. It is probably too small an outfit.”

On that basis I can’t help thinking that the ombudsman, given what has happened in the last six months, would kick that adviser into touch. I don’t think an “execution only” plea would satisfy them either.

In addition, I don’t see how the structured product operations, if they care about their distributors, can say: “It is not up to us to worry about the correct advice.” I heard this comment from at least one structured provider after the Lehmans Brothers collapse.

Of course these firms are not falling foul of any regulation or law. It may well be an adviser’s look out. Maybe I am wrong and the ombudsman may not care whether the counterparty is disclosed.

But from a personal view, I cannot see how any advice can be correct without knowledge of the counterparty given the global situation.

Personally, I would walk out of any IFA’s office where someone had tried to sell me one of these products without such disclosure.

In the first structured products crisis, much was made of how the marketing material used the counterparty to create a halo effect for plans, regardless of what risks to capital were involved. The market now knows that counterparties count for a great deal too.

Not disclosing the counterparty may, and I stress may, be appropriate for the institutional market – but it seems to be completely wrong for retail investors.

I think those providers currently issuing these plans without such disclosure should seriously think again. They should preempt Dan Waters and the FSA and go and find themselves a counterparty that will let them disclose their name, even if the headline rate is lower.

Of course, if these plan providers want to argue otherwise, they can do so at length on this website or in the newspaper anytime they wish to.

For me however, I think it is simply not enough to say: “Trust me, I’m a structured product provider”.


Blue Sky queries risk rating selection

Blue Sky Asset Management is warning advisers that AAA-backed structured products may be being marketed on headline credit ratings that might not offer a reliable categorisation of risk.

That sinking feeling

In estimating the cost of statutory regulation, most people would point to the cost of the FSA. Their beautiful offices and almost 3,000 well-paid staff cost the financial services industry over £300m per annum. The compensation scheme has during its existence paid out £1bn and has a payroll of £25m a year. That does not include bailing out Northern Rock, Icelandic banks, etc. Billions have been borrowed which the banking industry, if not nationalised, will have to repay.


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