The International Organisation of Securities Commissions (Iosco) is planning further work to address the issues raised by the ongoing credit market disruption in the structured products arena.
At its annual conference in Paris, the umbrella group of global securities regulators published the final report of its technical committee’s Task Force on the Sub-prime Crisis, which focuses on the failings of structured finance products in the market, and includes recommendations for improving such markets in three key areas: issuer transparency and investor due diligence, risk management by firms and prudential supervision, and valuation and accounting issues.
According to Iosco, the recent market turmoil had less impact on publicly traded structured finance products in some markets, and that secondary trading of structured finance products is generally opaque. As a result, one of its committees will consider the viability of a secondary market reporting system for different types of structured finance products. Another committee will review the extent to which investment managers that offer collective investments, such as mutual funds, to retail investors have invested in structured products, the type of due diligence they conduct when making these investments, and the degree to which these investment managers have been affected by the current market turmoil.
On the other hand, the Organisation for Economic Co-operation and Development (OECD), pointed to European banks as having to address the risks faced by the equity structured products they underwrite (which has a market value of €642.9bn), which could be at risk after heavy losses on structured credit.
“It requires attention just because it is so big,” said Adrian Blundell-Wignall, OECD’s deputy director of financial and enterprise affairs to Financial News Online. “Europe is the king of structured products and people should be thinking about this now. They are much more difficult to understand than mortgages.”
Blundell-Wignall also mentioned the risks posing structured products based on hedge-fund sold options because, although there is unlikely to be a collapse of a large asset management provider, there are a number of counterparty risks when dealing with hedge funds, especially those with high leverage and a concentration of assets in illiquid securities: “If you get a big equity market event and some large hedge funds fail, banks would have a problem and would need to use their own capital to make good in the commitments.”
Among the most threatened structured products are the so-called passive structured products or CPPI strategies, which are options replicating strategies to minimise losses but can have, according to the Bank of England, a negative impact on market liquidity if they are forced to sell.
As equity products decline in the credit crunch turmoil, CPPI-based products will move their funds to liquid assets such as cash and will be forced to sell their risky equity assets usually at poor bearish prices. These CPPI products were held responsible for the 1987 market crash.
