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| Keith Styrcula |
In 2001, structured derivatives bankers in the U.S. thought their moment of glory had arrived. The stock market had just crashed, the dot-com dream was over and U.S. investors were reeling from one loss too many. The market looked primed for structured products, but three years on and banks from both sides of the Atlantic are still struggling to find paradise. By Reporter Elinor Comlay. The U.S. is lagging five years behind Europe and Asia for sales of structured derivatives products, according to Keith Styrcula, chairman of The Structured Products Association in New York. "We have made some quantum leaps in volume terms," said Strycula, but he explained innovation in structured products is led by the demands of European and Asian investors. In the U.S. marketers are plugging products that in the field of derivatives are plain vanilla.
"The U.S. investor is more aggressive," explained Styrcula. "In the go-go nineties, people preferred to take straight up bets on single stock plays," he noted. "That was rewarding for several years in the U.S., but it took a market phenomenon for people to say, 'Oh, wait, there's another type of asset class?'" added Styrcula. The message of capital protected investment is only beginning to filter through to U.S. investors.
A typical structured product offering from an investment bank in the U.S. is the combination of an equity index option and a zero-coupon bond. The bond safeguards the investors' capital and the equity index option gives the investor upside participation in the underlying index.
European houses, faced with a domestic structured products market close to saturation, have used innovation to encourage investors to buy the latest product. But the U.S. is a New World for structured products in which the competition is less to create the most innovative product and more to create the one that can be explained and sold.
In spite of its backward appearance, the U.S. market has several attractive features for banks. The regulatory environment initially looks favorable: The Securities and Exchange Commission takes the place of over 20 different regulators in Europe. Al Plattner, head of European marketing at Citigroup in London, explains this is a big draw factor for banks because it means one structure can be marketed across the U.S. rather than needing to be adapted to local jurisdictions as is the case in Europe.
The arrival of European banks in the U.S. structured product market has not proved a catalyst to growth. Some argue this is because the U.S. regulatory regime discriminates against foreign entrants. But most officials agree the difference between European and U.S. investor cultures has been the biggest stumbling block for European banks. William Treen, structured product salesman at Morgan Stanley in New York, who has worked on both sides of the Atlantic in a similar role, says the banking culture of the two continents remains different. "More people [in the U.S.] have accounts with what in the U.K. we would think are stock brokers, but essentially are Merrill Lynch, Citigroup etc," says Treen. Americans will buy products from their insurance company and their broker, but use their bank only as a current account, notes Treen who explained this is very different to the European banking setup, where investors buy products directly from their banks.
Finding a point of sale, then, is clearly an obstacle for banks looking to market these products in the U.S. Buying a U.S brokerage house to distribute financial products structured by a European house is the obvious solution as Deutsche Bank, which bought Alex. Brown, decided. But industry gurus note there are few broking groups left to buy. The other distribution outlet for financial products is by direct issuance, which is where suggestions arise the U.S. regulatory setup is prejudiced against foreign houses.
Anna Pinedo, partner at Morrison & Foerster in New York, explains U.S. banks will likely have a registered vehicle from which they issue securities. Some European banks will also be able to apply for this, which Barclays Capital, UBS and CSFB already operate, but they need to produce U.S. accounts which can be costly and time-consuming. The vehicle, called a shelf, is critical for distribution to retail investors in particular. The Structured Products Association announced in October that the amount of structured products issued through a registered shelf had risen by 20% on last year.
Pinedo says the platform method means products can be sold to retail clients, which is appealing to investment banks because of the size of the retail market. The Securities and Exchange Commission in November announced proposals to improve the speed with which notes can be issued from registered shelves. "If this is adopted, I think it will revolutionize the market," says Pinedo, who believes the changes would encourage more issuers to choose this route.
The highly-regulated environment in the U.S. has prevented European banks from marketing not just to certain sectors of the market, but also certain types of products. Ted Maderas, marketer at Commerzbank in New York, noted his business does not have a registered shelf and has had to focus on the type of product suitable for a privately-negotiated deal for high net-worth individuals. This division, between banks with a shelf and those without, does not exist in Europe, noted Maderas.
Commerzbank in the U.S. has concentrated on structuring capital-protected fund of funds. This format is popular in the U.S., particularly after traditional mutual fund investors saw their returns dwindle as the stock market plummeted. Treen agrees the fund-linked strategy has proved profitable for several banks in the U.S. "Mutual funds are the most established financial business in the U.S," he noted. Bank of America, for example, has not made significant inroads into the equity-linked structured products market, but rivals say it has built up a successful structured business by providing capital protection for fund investments.
The U.S. investing public remains skeptical as to the value of paying for structured investment insurance-type products. This is a battle both European and U.S. houses are having to fight. "Structured products have to be sold. They're not bought," said Styrcula. Banks have to convince brokers the products work in order to be sure they will sell them to potential investors, added Styrcula.
Tom Ricketts, ceo of Incapital, a securities firm which started selling structured products six months ago, agrees with Styrcula that broker education is key. Incapital has set up bondschool.com to help keep financial advisors up to date with the latest financial products. "We have surveyed brokers in the U.S. and it always returns the same answers. They say they have no information," said Ricketts. As Styrcula noted, structured products need to be actively sold by brokers, so banks need to win their confidence. The cultural change required to get the market off the ground needs to begin with persuading distributors, such as brokers, of the value of capital-protected investment.
Bankers are also keeping their fingers crossed the SEC's proposals to change public issuance requirements signal a broader move by the regulator to update securities law in the U.S. With a regulator behind the structured products market, those who bet on U.S. investors to become the largest consumers of derivative products could find themselves in the money after all.
