In a difficult economic market with low interest rates,
widespread austerity measures and a substantial volatility, it
can be difficult to get a grasp on where the structured finance
market is heading in 2012.
However panelists at IFLR’s Structured
Finance and Derivatives Forum at the Grand Connaught Rooms in
London on February 9 were brave enough to give their thoughts
on where the market was heading.
Julian Velarde, head of derivatives London, CIB
legal at BNP Paribas said it’s important to first
understand the drivers from an investor and
Investors are looking for three elements from their
structured products: a reduction of issuer risk, especially
financial institution risk post-Lehman; increased transparency;
and less leverage.
Issuers and distributors on the other hand are
driven by the need to comply with new regulation, protect their
margins and raise funding and liquidity.
Other drivers will be Europe’s ageing
population and the concurrent dismantling of final salary
schemes, and increasing wealth and therefore interest from the
1. Segregated or collateralised
Programmes that are segregated or collateralised
are already popular, and it’s likely to stay that
way, according to Velarde.
Segregated programmes allow investors to have a
pure exposure to clearly -defined risk and should strip out
issuer risk. Collateralised programmes are similar –
investors take exposure to the full credit of the issuer but
also get collateral in part or whole.
"We believe both of those structures will be very
successful in 2012," said Velarde.
Regulatory change is likely to be a complicating
factor however. The European Market Infrastructure Regulation
(Emir) will require compulsory clearing, and these products
usually have a derivatives component between the SPV issuer and
"So where those derivatives are relatively vanilla
they will need to be cleared, and where they’re
not vanilla they may require bilateral collateralisation," he
In addition, segregated programmes may not be able
to use the intra-group exemption in Emir as they typically use
an orphan SPV.
Darren Greenberg, director and senior legal counsel
at the Royal Bank of Scotland said collateralised programmes
can be beneficial, but it’s important to look at
the collateral backing the programmes.
Collateral rated AAA is good but can be scarce,
making it more expensive and potentially impacting the
"I query whether that AAA collateral can be used in
a cost effective manner for the investor," said Greenberg.
All structured finance issuance raises funds, but
some structures raise more than others.
Banks will be the key issuers of these fundraising
products, said Velarde. In particular, this year is likely to
see segregated programmes established by smaller entities (who
are not normally issuers) accessing the capital markets to
effectively provide investors with a product linked to their
An SPV issuer under a segregated programme will
issue securities, take in the funds, and can then invest a
large part of those funds in a deposit with the small bank,
which may well be the distributing bank.
The SPV then invests the rest of the proceeds in a
derivatives product with a sponsoring bank. This gives
investors a pure risk product tied to the credit risk of the
"In order to strip out the sponsoring bank credit
risk you can have collateralisation of the derivatives product,
and at the same time provide small banks with funding.
That’s got to be a win-win situation," said
In an economic environment with low interest rates
and where leverage is out of fashion, investors will be on the
lookout for yield. According to Velarde, one way will be to
invest some of the upside in the performance of the underlying
in exchange for a higher yield.
Another way is to combine a number of different
risks; rather than multiplying risk with leverage, he said,
some investors may look to take on more than one risk in any
Selling credit protection is one example, although
this can only be used for sophisticated investors.
"But we do see sophisticated corporate buyers
coming to us and saying 'we’re happy, or happier
than the market, with the credit risk of our sovereign, so
we’re willing to sell credit protection on the
sovereign as part of this product," he said.
But regulatory change is likely to cause problems
– for example, short selling regulations are likely to
restrict the short selling of sovereigns.
4. Products that provide
Despite increasing correlation across asset
classes, diversification is still seen as a useful way of
maximising yields, said Velarde.
There are three ways to achieve this. First, by
using multi-asset proprietary indices that are built around a
number of different classes of asset.
Second, by using managed account platforms that can
be similar to classic fund of funds but without the Madoff
Finally, by using managed algorithmic funds which
use an algorithm to select the best performing proprietary
indices for a particular economic set of circumstances, and
have a human being involved for when markets move in strange
Again, the problem is that regulators have a
growing suspicion of proprietary indices, he said, with product
intervention and greater transparency more likely.
"The other element is algorithmic trading, which is
going to become more difficult and which Mifid 2 will probably
regulate to a greater degree," he said.
The final structured products likely to be popular
in 2012 are those designed to comply with the rules of a
While these products will in essence be simple,
interestingly Mifid II will have the effect of classing these
products as complex, said Velarde.
Finally, with banks facing pressure on margins, he
predicted a move towards e-business and click-to-trade using