Structured products market faces challenges and opportunities as credit crisis reshapes industry

By Kenneth Lim

New York, Oct. 2 - The structured products market is going through an industry-changing period and must grapple with investor risk aversion, greater concern about credit risks and challenges in education and transparency, panelists at the Structured Products Association fall conference said Thursday.

But the future also presents opportunities in up-and-coming products and new distribution channels, the panelists said.

Train went off-track

The collapse of Lehman Brothers Holdings Inc. in September and the domino restructuring of U.S. banks that followed have created a significant "disruption event" for the structured product industry, SPA chairman Keith Styrcula said in the conference opening address.

"The train went off the track pretty dramatically this last August and September," Styrcula said.

The events were not the making of the industry but are likely to cause major changes, he said.

"We know that the landscape will never be the same," Styrcula said.

Drop in volume

Many industry insiders at the conference reported that volume had slowed after Lehman Brothers' bankruptcy.

One distributor said the distributor's firm was mostly in "service mode" because the investment advisors who had taken a hit were "shell shocked" and not doing much.

Mark Kolodzinski, who holds the newly created post of director of structured products at Bonds.com, Inc., acknowledged that the current market problems hit at a bad time for him.

"It's certainly slowed things down," he said.

Brad Livingston, vice president of structured products for Advisors Asset Management, said many investors were not sure about where to put their money and were awaiting greater clarity in the markets.

Lehman fallout not settled

Many of the wary investors are still waiting to understand the fallout from the Lehman collapse, which has left holders of the bank's structured notes unsure about where they stand in the bankruptcy proceedings, Livingston added.

Thomas Livingston, principal and executive vice president of McGinn Smith Co. Inc., said his firm had difficulty selling reverse convertibles because of questions raised through Lehman's breakdown.

The main uncertainty was how reverse convertibles would be treated in a default, Livingston said; do holders claim as senior unsecured creditors or, if the product had been knocked out, as equity holders?

"I never got a good answer," he said.

Capital protection gains ground

Principal-protected products are experiencing a surge in demand, many panelists said.

Certificates of deposit, in particular, which are insured by the FDIC, are on the rise.

"Having that FDIC insurance in a very challenging environment is very important," Livingston said. "We can go out with a triple A rating and they don't want to hear about it."

Other panelists also reported better interest in some absolute return structures, such as long-short products, negative correlation asset classes and strategy-replicating indexes.

One issuer noted that some clients, rather than shying away from capital-at-risk products, were seeking leveraged notes that could allow them to pursue opportunities thrown up in the turbulence.

An industry-supported ETN?

Joe Inzerillo, a legal executive at BNP Paribas who focuses on structured products, also suggested the possibility of a "next generation" exchange-traded note.

The idea would be to offer the same product through multiple issuers with issuers guaranteeing one another's ETNs. If one of those issuers defaulted, the rest could help to support the product, Inzerillo said.

Transparency, simplicity key

Some distributors saw the current slowdown as an opportunity to improve education efforts.

Transparency and simplicity were also repeatedly highlighted as key challenges for the industry to gain better acceptance.

Inzerillo noted that the industry has made "tremendous progress" over the past years in terms of documentation, with greater consistency of nomenclature and more reader-friendly brochures and prospectuses.

But a fellow panelist also said better standardization of nomenclature would make it easier for investors to understand structured products and help to reduce any misunderstandings about the complexity and risks of structured products.

Panelists also warned of closer scrutiny from regulators.

Styrcula said the Financial Industry Regulatory Authority (Finra) was drafting an investment alert on structured products. Finra could not be reached for confirmation.

From hedge funds to bank branches

The industry continues to explore new ways to offer structured products to issuers.

Wavecrest Asset Management, a new investment firm believed to be one of the first that will focus on structured investments, launched its first hedge fund earlier in the week.

Wavecrest managing partner and co-founder Jeremy Berman said the new fund, called Wavecrest Partners Fund I and with less than $10 million in assets under management, was started even in these tough fundraising times so that he could establish a track record.

Ideon, a relatively young entrant to the U.S. market from Spain, is also hoping to open new channels through commercial banking retail branches.

The company is working with commercial banks to offer simply structured products - structured CDs, for example - linked to well-followed indexes that can be customized for clients through a convenient system, Ideon managing director Matt Murphy said.

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