Derivatives financial products used to be the preserve of institutional and sophisticated investors. Today they are present in most personal financial transactions and cover a wide range of products including insurance, mortgages, pension and even savings. In most cases, the derivatives features of the products are invisible to ordinary investors. For this reason, regulators often ask issuing firms to highlight the potential risks embedded in the products.
Structured products emerged because ordinary investors with low starting capital did not have a direct access and therefore could not trade certain types of asset classes that may require initial high capital investment. Structured products combines one or more underlying financial instruments, typically bonds, a basket of indices and derivatives, into a single package that allows investors to make bets on the direction of stocks, commodities or other investments. Structured products can therefore offer the opportunity to gain exposure to underlyings such as commodities, high volatility stocks and even a large number of stock (i.e. basket of indices) without actually buying them.
The Structured Products Association estimates that nearly $49 billion of structured products were issued in the U.S. in 2005 making it a rise of 57% from 2004. These figures include institutional purchases. According to Arete Consulting since 1995, over 175,000 individual products have been recorded from over 980 companies in US, UK, France, Italy, Spain, Germany, Belgium and The Netherlands with new products added almost daily. These products in total represent sales of over 700 billion euros. In Germany the market for structured products began in the early 1990’s with the first issues of covered warrants
Generic Structured Products
Accounting for structured products
Since then, the market has grown reaching 22 billion euros in 2005, up from 10 billion euros the previous year. On a global scale, not including issues in the Middle East, volumes were up at 230 billion euros, compared to 200 billion euros in 2004. However, the market remains relatively fragmented with conflicting legislations in many countries making it difficult for issuers to distribute their products outside of specific jurisdiction. In addition, strict accounting rules for derivatives mean that issuers have become more weary of the impact of liabilities on their balance sheet because most structured products are customized, unique, potentially illiquid and therefore difficult to price.
Complex structured products are creating many challenges to regulators and markets participants. Some of the challenges have been highlighted by industry groups such the Group of 30 guidelines and the Counter party Risk Management Policy Group.
Since 1988, the NYSE provides both debt and equity structured products including capital securities, mandatory convertibles, repackaged securities, equity-linked and index-linked securities, and corporate debt securities traded on the Exchange floor. The NYSE trades more than 550 structured products with a total market value greater than $120 billion. In Europe, Stuttgart EUWAX (Germany) lists warrants, knock-out products, exotic products, investment certificates and reverse convertible bonds. On the other hand, London Stock Exchange has created a new market segment to accommodate the rise of structured products.
A significant amount of structured financial products are sold directly to investors without the need for formal sercurities exchanges registration. This is the case for most savings and mortgage products. It is a fragmented market and data is difficult to gather on the size of the market. Insurance companies and retail banks dominate this market for example in the United Kingdom and Australia. Future Value Consultant (a UK based valuations services for independent financial advisers and products issuers) has recorded 650 products since 1999 specifically single-index linked products linked to either the FTSE 100 and Dow Jones Eurostoxx-50.