Over the last few years, the structured product industry has responded well to regulatory and transformational change.
It has risen to meet, in certain cases, extreme challenges. Now, however, it faces an inflection point. Divergent approaches to technological adoption have created a patchwork system able to function year-to-year, but in a fashion that risks stifling long-term innovation and perpetuating processes which produce uneven service levels and lifecycle management inefficiencies.
The root cause of many of the issues lies in the bifurcation between the automated and manual processes the industry has adopted over the years. By and large, the banks have embraced one or the other, creating a twin-track system that has inadvertently embedded inefficiencies and variable service levels across business workflows.
Structured product desks at private banks still cultivate product ideas individually with multiple issuers
Traditionally, of course, processes have been entirely manual. These are resource intensive and relatively inefficient, something that is evident from the product development stage all the way through to product maturity.
Structured product desks at private banks still cultivate product ideas individually with multiple issuers because they lack a single venue to test and price concepts across the market. Relationship managers must present ideas back to the client with all the suitability controls, procedures and documentary evidence required, with no single hub to store them. It can be a laborious for all parties. On any given day, an issuer may receive numerous requests from buyside clients to price a similar product, all in different formats, requiring them to respond differently to each one.
Of course, this multiplication of inefficiency does not end there; it runs through the entire manufacturing and distribution process, rendering onerous and time consuming everything from evidencing best execution to decision reviews. It does not help that some of the tools utilised are fragmented and, in certain cases, not necessarily fit for purpose.
Crucially, all these inefficiencies create expense. For the banks, the base level of costs associated with an entirely manual process mean there is a high hurdle rate to clear before a new product would make economic sense. As a result, there tends to be a narrow concentration around products with mass appeal – ie autocalls – and those which, while attracting a smaller client base, generate much larger trades. Consequently, innovation is frequently challenged by the minimum costs of product development and distribution.
The flipside of fully manual processes is full automation. Many issuers now have single dealer platforms which price and trade standard products such as autocalls and reverse convertibles. These can make the initial process of price discovery, documentation generation and distribution relatively fast and efficient as it is based on one product, one investor. But while these platforms allow for certain enhancements – the addition of more underlyings, for instance, providing flexibility on the inclusion of new stocks – they do not facilitate the creation of new products.
The challenge here is that new products require, as with the existing products on the platform, fully automated pricing, documentation and regulatory processes, as well as trading. For an investment bank, adding new products would represent a huge investment of time – perhaps six to 12 months – and capital. Given the nature and size of the investment required, a bank is likely to expect P&L-moving volume within a few months of going live. The risk of that not happening is, understandably, one few are willing to take.
Often, the processes around managing the subscription, the orders, the book building and finalising the settlement are performed manually by issuers
So how does the industry move forward? The answer lies in the middle ground between manual and full front-to-back automation. That, in effect, means streamlining core elements of the process to allow companies to innovate and provide scale on a lower cost basis.
Part of this would involve reducing or removing some of the costs for both the buyside and the sell-side through tools that allow them to operate more efficiently without significant upfront investment. Standardising price requests for non-standard products, for example, would allow unautomated banks to respond to buyside clients in a more consistent and scalable way. If both sides use common platforms, there will be more predictability, giving issuers the comfort that clients will request information in a very similar way, not in numerous different ways.
Documentation, a critical component of workflows, is another key consideration. Product ideas must be accompanied by, among other things, a term sheet, a Kiid and the appropriate regulatory documents, and many issuers use third-party service providers to help them to deliver and build on those. But issuers still must have multiple connections to multiple clients to send all those documents and manage that flow. By using platforms that can retrieve that documentation on their behalf wherever required, document generation can become a one-time piece of work for them, eliminating the need to pay multiple times to provide the same information.
Efficiencies can also be made once the product has been created. Often, the processes around managing the subscription, the orders, the book building and finalising the settlement are performed manually by issuers. It can involve operations teams managing the breaks and inefficiencies that may appear through the process. Having a workflow that normalises that but is not tied to straight-through-processing will help this process become much cleaner. Ultimately, volumes should grow on a particular product, giving issuers the incentive to invest in automating rather than semi-automating that product. That would help break the current impasse, where investment is lacking because the volume does not justify it, but the volume is lacking because the service level does not make it worthwhile.
Solving the problems during the manufacturing and distribution stages is critical to managing the lifecycle of a product. Whether it is a bespoke deal for an individual investor, which might be highly standardised, or a customised deal for 500 investors, the client service expectations of lifecycle management remain the same. What is its value, what is its performance, should I still hold it, and how does it fit within my portfolio? All these are common questions that must be answered irrespective of trade size. While there are many variations in the manufacturing and distribution elements of the process, as soon as a product is placed with an investor it is crucial it is serviced in a highly efficient, highly standardised way. These are living, breathing assets which need to be actively managed in a client’s portfolio.
The industry has undoubtedly proven its resilience in recent years in the face of daunting challenges, partly through the deployment of technology. Now we must ensure that automated platforms and processes do not oblige banks and wealth managers to duplicate tasks in perpetuity, while also tackling the lack of automation in other areas which preserves costs in the system and discourages innovation. Ultimately, we all want to see less fragmented service levels and better lifecycle management, but these outcomes will be hard to achieve without solving the problems in the manufacturing and distribution stages. Doing so will be an ongoing and active journey, but it is one on which the industry must embark.