The Structured Products industry has been slow to adopt common standards of practice and documentation, but new regulations are offering an opportunity to catch-up and help the industry compete in an increasingly digital marketplace for retail investment.
ISO TC/104 may not sound like an interesting term but, being the internationally agreed standard for design of freight containers, it has transformed how goods are transported round the world since its adoption in the 1960’s. It serves as one of the biggest visible examples of how standardisation has catapulted an industry’s productivity to the next level. The effects are often transformative and enable an industry to evolve and innovate and companies to focus on the differentiating aspects of their business.
In securities markets, standardisation has helped unify cross border trading and settlement processes for investors. Across derivatives markets, standardisation in futures and options and the creation of common definitions in contracts for derivatives driven by ISDA, have heralded a rapid global expansion of listed and OTC derivatives markets since the 1990’s. However, this has been less so for the structured products industry perhaps due to the lack of homogeneity of product. This may be a factor constraining the growth of an innovative market that serves a steady but growing community of investors with specific return demands. One only has to look at the success of UCITs in Europe (from EUR4trn to nearly EUR10trn in ten years) to see how common standards (aiding investor protection, transparency and regulatory oversight) help an investment market develop. Could structured products benefit from a greater adoption of common standards to define and describe products in a consistent way?
One reason for the lack of standardisation has been the nature of the product. Structured products (sold to retail investors) are typically offered as securities, as investment products issued from an issuer’s own securities issuance programme. This programme is owned, maintained and updated by each issuer (with their counsel), and the prospectus reflects an issuer’s own setup and practices for how it describes itself, its products and business. Product transaction documentation needs to be derived from the issuer’s own underlying prospectus, with its individual style and language. However, there are two significant and recent regulatory developments that may provide impetus towards a greater effort for industry standardisation in this space:
- The PRIIPs regulation that went live in Jan 2018 required creation of a Key Information Document (KID) to be prepared in plain language, that was both clear and comprehensible to the retail investor. One objective of the regulation was to improve cross comparability between different types of product, to allow investors greater choice which would improve transparency and competition. This regulation acted as a catalyst for issuers (faced with a tight deadline to deliver a major new disclosure document incorporating complicated analytics and simulations to derive scenarios and risk indicator), to describe structured products sold to retail in a more comprehensible way. One group of banks chose to collaborate on a standard design for payoff templates, pool their collective knowledge and efforts and share the results and know-how. The result was a large library of standardised product templates, drafted in a common style and format. The benefits were clear, the participants had created a set of templates that they would all adopt, that describe the products in a clear and consistent manner, delivered in time for a fraction of the cost than if each were to perform the undertaking itself.
- The EU Prospectus Regulation ((EU) 2017/1129) which comes into effect in July of this year will require an update to every prospectus under which a structured product is issued to investors in the EU, demands that wording be drafted with a greater comprehensibility, written in plain language, with the requirement that sections be made simple, clear and easy to understand for target investors.
Why is it important now?
Whilst structured products may target an informed and expert segment of the investor market, the rapid digitalisation of the consumer is fuelling their expectations from providers in the structured products space. Unlike for vanilla ‘flow’ products, the complexity of payoff features across a wide variety of product types has constrained the move to a digital model. That is now changing fast, and consumers’ expectations for a fully digital experience will have several consequences, but product manufacturers will need to exploit every opportunity to streamline the execution process in order to stay in the game, distribute products under ever more competitive circumstances that remain compelling for investors against alternative ETFs and UCITS products.
What to do?
The biggest frustration that we hear from product origination teams is the long lead-time, high costs, and many restrictions on releasing new products that their clients demand. An initial focus on two areas could help address this:
- Standardisation of the product final terms (and achieving a consistency with KIDs and Prospectus definitions) across the issuer community. (The German DDV association has been pro-active in pushing for common text in parts of the prospectus.)
- A single common taxonomy of products and the adoption of common data standards (for describing products electronically) amongst issuers, distributors and vendors.
Both could make steps toward simpler post trade processing, lower costs, and help investors’ education, and in the longer term facilitate the digitalisation of issuance processes and consumer experience. With growth in outstanding volumes1 of issued products stalling, can the industry really afford not to?
1 SRP Data for Global (and Europe) Volume outstanding 2018 vs 2017.