Posted on March 24, 2015
Retail structured products are a very emotive kind of financial investment and they come with a particular set of product design, distribution and marketing challenges. We talked to Rob Reid, formerly of Santander and Investec, and now of Econumy and AlwaysOrg to get his expert insight into structured products.
This is what he had to say.
A little bit of background
Retail structured products involve the investor loaning money to an institution in return for a defined payment (or payments) at a defined point (or points) in the future. These products generally offer asymmetric risk profiles and aim to access market pricing opportunities, which other traditional assets classes do not.
In reality, a lot of retail products are structured in nature. Annuities, with-profits endowment policies and fixed rate bonds are all examples. So why all the fuss? In my mind, it comes down to understanding, transparency and the difficulty in demonstrating the share of the returns between investor and provider.
Historically, companies would work from a good idea for a particular client(s) and then work out who else they could sell to. Thankfully business practises have evolved somewhat, and with helpful guidance from the regulator, the starting point has shifted to the intended target market, so there is more focus on the end customer.
The real challenge now is to deliver products that both demonstrate and are capable of delivering fair outcomes to customers, while balancing the commercial pressures and associated business risks.
Managing a retail structured products business
There are three components essential to a successful business. Each part needs to manage costs and risks effectively to ensure that the gross returns are fairly apportioned to the customer and provider.
- Manufacture. A scientific approach is required here. This is where you look at the market pricing, the hedging costs, the funding rate and product delivery vehicle (typically deposit, note or fund). This is pretty standard for established players where the risks and costs are well defined and understood. The lowest cost provider is a good place to start.
- Product design, marketing and distribution. This is about applying best practises and improving them. To name a few:
- Identifying your target market at the outset
- Designing products to meet customer needs
- Communicating relevant information from provider to distributor to customer
Promotion, education and training need to be pitched accordingly, allowing for continuous feedback to highlight good and bad practises.
A key part of the success that Investec had in making such a rapid entry into the retail structured products market lay in doing things simpler and better, and communicating the distribution strategy directly to Financial Advisers. Working with Talisman we developed the ability to deliver a coherent suite of products on a continuous basis, efficiently and cost-effectively.
- Governance and conduct risk. This is about bringing the other two components together to deliver targeted products with appropriate oversight and challenge to ensure commercial imperatives are balanced appropriately with fair customer outcomes. It means having controls around the business, managing conflicts and evidencing best practice.
The products need to do what they say, reach the intended market and represent ‘good’ value. The price for getting this wrong is substantial.
A challenging context
The ability to create simple, attractive retail structured products is arguably harder than ever given the current low-return environment and the fact the financial system has limited appetite for term cash.
On top of that, the perceived complexity and risk involved in retail structured products, the high costs associated with marketing and distribution, and the penalties around conduct risk failures has meant a lot of big players have simply pulled out of the market altogether.
Those that remain are still grappling with the need to offer targeted products that are easily explained, meet customers’ needs and are competitive compared with other traditional investments. The need to evidence this is a significant challenge.
In an ideal world, structured products would become a core part of an investment portfolio. Higher sales volumes mean lower marginal costs, creating competitive advantages meaning a better deal for customers. This in turn reduces conduct and associated mis-selling risks and ultimately the products make more commercial sense to the provider.
Structured products were on this journey but the regulatory environment and their complexity has made them harder to sell. Think of it like this:
- Manufacturers have to educate Financial Advisers. This is like a professor who has to pitch information to students in a way that’s understandable and absorbable.
- Financial Advisers then have to explain products to customers in an understandable way, while making sure the important stuff is still covered. This in turn is like a student who talks to a friend on a different course and tries to distil and simplify the information further, without losing the core details.
There’s a lot of room for miscommunication and error in all this, but technology may hold the key to reducing risk and speeding up the distribution and education process.
AlwaysOrg (Rob’s current venture), for example, is a private and secure web communications service. It’s designed specifically for the financial services market and means information can be delivered and shared more efficiently from start to finish, with an auditable record to evidence the advice process.
Like a lot of complex financial products, structured products might be hard to sell, but that doesn’t mean they’re not useful for investors. Reduce the risk and speed up distribution, and providers might be more willing to offer retail structured products as a core, fairly priced proposition making the market better for everyone.