Vito, structured product volumes have fallen dramatically since the crisis. Is the asset class still relevant?
Yes, I strongly believe it is. And I think it is important to get this message out. People have been using derivative devices to transfer risk for millennia, and modern structured products still provide this essential function. They offer a clear value to investors in a wide variety of situations, and shouldn’t just be written off en masse.
And yet there is no doubt that the industry suffered after the crisis, and has had to adapt. What in your opinion are the most important changes?
I would point to two things. On the client side we see a clear desire for simpler products. This goes back to the immediate post-crisis environment, when there was a tendency for clients who did continue to use structured products to stick to the more vanilla structures. I see this as a positive development. I think we as an industry needed to drop some of the complexity we had before the crisis, and our clients steered us in that direction. Then there is a clear trend toward more transparency on fees, driven above all by regulators. In the UK, for example, the Retail Distribution Review, or RDR, completely bans product distribution fees – what we in Switzerland call retrocessions. It further requires all fees to be clearly documented and agreed ahead of time with the client. In other markets there are similar moves going on. In Switzerland, while retrocessions are still allowed, since March of this year they have had to be disclosed. There are also discussions on a European level for similar mandatory disclosure as well as providing easier means for investors to compare prices. So we are definitely seeing more transparency, which is another positive development.
It’s hard to deny that transparency in general is a good thing, but for the structured products industry it also means a major transformation. Is this really a positive development from the supplier standpoint?
Yes. As a result of such transparency, clients will have a much better idea of what their advisor’s interest is, if any, in showing them a product. This will help rebuild trust in the asset class, which is very important at the moment. That said, I want to be very clear that in the past, structured products were not sold solely on the basis of the distribution fees. First and foremost, these products meet a client need. By being more transparent, I think we can help steer the conversation back to the value proposition.
Will business models be changing as a result of these developments?
I do believe that the structured product industry will evolve further. One important way it will do so is in the context of the general trend to fee-based advice. Banks today are considering building inducement-free product shelves, and are in discussions with their clients about a new pricing model based on advice, not individual products. So you may start to see products, including structured products, with no distribution or other types of fees, and instead a flat fee arrangement based on the value of the assets being managed. All this is very preliminary, of course. We will have to see how things develop. But I think there will be support for such models because they really are more transparent and better align the interests of the client and the financial advisor. For the structured products industry there are therefore two steps. In the first we see more transparency. In the second we potentially see a change in the bank/client relationship.
That sounds like a non-trivial change. Are there no worries for structured product providers?
Of course there are concerns. Some are worried that the move to transparency will put downward pressure on margins. Others fear that these changes will lead to a continued reduction in the use of structured products overall. Certainly lower volumes and tighter margins would not be a positive for the industry.
Are these worries justified?
I don’t think so. In fact, the reality might be the opposite. Just take a look at some of the jurisdictions that are being a bit more aggressive on transparency at the moment, like the UK. Even after RDR we still see structured products being used. To me this is a clear indication that these products do indeed behave as we have always said, and that they do address a clear client need. So I don’t think the fears are warranted. In fact, there is a positive here, and it goes back to helping restore trust. I personally believe that many clients think the margins on structured products are higher than they really are. A clearer view on fees may very well help clients look at these products more positively again. And that is not just me talking. The Swiss Structured Products Association, for one, clearly thinks that transparency will help better position the asset class.
Is there anything else the industry can do to improve the reputation of structured products?
Yes. We must do a much better job of educating clients, of explaining what these products really are, how they work, and how they add value to a portfolio. I usually describe structured products as an alternative to a direct investment, one that for example can help you better tailor your investments to your risk preference. To take a simple example, perhaps you are excited by some Internet stocks, but are concerned about the risks and potential volatility of investing directly into the Ali Babas and Googles of the world. Through a structured product you can get some exposure to that sector while partially protecting the downside. With structured products you can also tailor your investments more toward your own market expectations. Certain structures, for example, let investors benefit from sideways trending markets. Direct equity investments cannot offer this. Yet many investors still don’t clearly understand these advantages, and the relationship between structured products and their underlyings. We must simplify and clarify this message.
“I strongly believe structured products are still relevant.”
If structured products are so useful, why did they suffer so much after the crisis? Where did this bad reputation come from?
I think several things happened. After the financial crisis many clients suffered losses on all kinds of investments, not just structured products. This was naturally traumatic. Structured products, however, perhaps because of their complexity, were singled out for blame. I don’t think that’s necessarily fair. The average structured product investor may in fact have done slightly better in the crisis than those only doing direct investments. Neither beat cash, however, so the outcome was still negative, which contributed to a loss of faith in the asset class. On top of this, before the crisis many structured product investors became perhaps a bit too fixated on trying to exploit the most complex products. When the crisis hit, this added to their bad reputation. I think the strong preference among clients for simpler structures, which I mentioned previously, can be traced back to what happened during the crisis.
Are you worried about a return to complexity?
No. Today we have much different discussions with clients about what they want, discussions which are centered around these more established, mainstream structures. Since the crisis we have also improved the discussion around client suitability, which has been a very strong learning. Across the industry standards have improved in this regard, and regulation is helping solidify this trend.
You’ve said regulation has been a positive, by for example increasing transparency or helping restore trust. But isn’t it also adding cost, and should that be a concern?
Costs are definitely on the rise, although not necessarily when it comes to manufacturing a single instrument. There we have become much more efficient, with easier structuring, straight-through processing and so on, so costs have come down on that level. But this has been counteracted by more stringent regulatory standards: documentation requirements, suitability requirements, cross-border issues, and others. That has added to the cost. Interestingly, the current preference for more mainstream structures helps us a great deal here, because it enables us to keep costs in check to a certain extent. The simpler structures are less expensive.
So basically today we are seeing banks selling large volumes of mainstream structures?
Yes. We are more centered around some mainstream structures, and then providing customization. And this is the area where you are seeing the most innovation. While structures are simpler, we have become much more efficient and flexible in tailoring them. At UBS, we can now easily accommodate individual wishes in certain kinds of products. You can call me today and I can, for example, do a GOAL or Perles Plus for you on Nestlé in no time. If another client calls me 10 minutes later and wants to do a GOAL or Perles Plus on Novartis with a different maturity, we can do that instantly too. Within these mainstream structures we and our competitors have become more agile. That’s the future.
Speaking of the future, in ten years time, where do you see the industry? What should banks be looking at?
First off, I am very confident that structured products will continue to be used because of their ability to fill a clear client need. I really cannot stress that enough. In terms of the big picture changes, I believe that this move away from retrocessions to fee-based advice is the most important trend. Considering their strong value proposition, that should be a plus for structured products, which will have a clear place in well-balanced portfolios. More specifically looking at banks, I think we must respond better to the regulatory changes in terms of aligning our processes to the new requirements. After all, we are only a few years into this, so it’s no surprise that there is work to do in this area. I would say it’s important for us to further improve on our processes through proper IT platforms. There is a lot to gain both in efficiency and convenience with the right tools, making them more user-friendly, putting more products onto the platforms. This is a very promising area for our industry.
Vito Schiro studied law at the University of Zurich and graduated from the University of St. Gallen with an MBA. He began his career at UBS in 1993 and assumed the role of head of Equity Structured Products and Corporate Derivatives in Switzerland in 1998. From 2010 to 2011, he was responsible for structured products across all asset classes globally. In addition, he has headed the global IPS Advisory Solutions area since 2011 and the regional IPS area in Asia since September 2014. He has one child and is an enthusiastic athlete (soccer, jogging, mountain biking and skiing).