The SRP global database lists 2,099 CPPI products in 25 countries, with the greatest concentration in Australia, Canada, France, Italy, Sweden, Taiwan and the UK, with total sales of $168bn (€134bn/£109bn). A significant proportion of these products will almost certainly have cashed out during the current turbulent market conditions, prompting a variety of responses from providers.
“We are close to the floors and some could have fallen through, but I think it is an opportunity to regenerate the CPPI element within these products or come up with alternatives,” said Barclays Wealth director Colin Dickie. “Talking very generally I think if some of the products have dropped in net asset value, providers should consider providing alternatives to clients that adapt to their timing. The rationale for developers of CPPI products is unchanged. It is all about designing a product with the ability to de-risk, and products with a potential to lock-in market movements will be attractive. We could be at the beginning of a new cycle,” he said.
Given the bad press internationally that structured products and derivatives in general usually attract in market downturns, it is not surprising that providers are often reluctant to be specific about their own products.
RBC Canada, however, thinks tackling the issue head on is the best solution: the bank has informed investors on its website about the recent cashing out of some of the CPPI products on its catalogue and has issued two new CPPI products exclusively for their investors.
The new RBC notes are only available to note holders of existing RBC IA Clarington Deposit Notes, which have undergone a ‘protection event’, and the bank waived some deferred costs that would otherwise apply to the sale of existing notes. The growth and income products include a coupon feature aimed at reducing the probability of a protection event: the monthly coupon is only paid if the portfolio is greater than $110 per note.
Equally, back in January this year, Barclays gave Dutch investors in its cashed-out Holland Capital Certificaten the opportunity to rollover their investment into Global Bond Trend Certificaat, which has 100% participation in the Global Bond Trend Index. Barclays’ Netherlands operation said at the time that it wanted to rescue investors from a seven-year-plus wait for their €60m back.
This wait, of course, is the fate of investors whose traditional-format CPPI products deleverage to the point where they no longer have any participation in the risky asset, and this ‘path dependency’, highlighted in the market downturn of the early 2000s, prompted the development of second and third generation products. “We had similar situations in the market not too long ago [2002]. And the market reacted,” said one banker who did not want to be identified. “As CPPI is path dependent, it is very important to offer long term strategies that are not standard, and are a little bit smarter than the pure algorithm.”
Later release CPPIs come in many variants, all of which aim to mitigate the effects of path dependence, including lock-ins, crash protection, minimum equity exposure, or VPPI structures which decrease the multiplier if volatility spikes. Some structures also include volatility cap mechanisms.
Mathias Westling, co-head of Nordics and Baltic's for equity derivatives & PIP sales at RBS, said the bank is selling a lot of dynamic strategies based on 20-day realised volatility of the underlying, rather than the spot level of the underlying versus the bond floor. “Our dynamic strategies have a lot of advantages versus a CPPI… For example there is no cashing out element, although, the exposure could go to zero under extreme volatility, but as soon as volatility risk drops the exposure will go back up again,” he said.
The underlying does not have to fall for exposure to be reduced, but it could also occur after large gains if the market turns shaky. “As it is measured over a short period it is quite reactive and the problem for [CPPI] of falling behind when the markets turns is strongly reduced for DS,” he said. “Another advantage is that because they are based on risk/volatility levels they benefit from the fact that markets tend to rise steadily (low volatility, high exposure) and crash sharply (high volatility, low exposure), so they use the so-called negative spot-volatility correlation seen in most markets to its advantage.”
Bernd Spendig, head of structuring for equities, commodities, mutual funds at HVB-Unicredit Group, points out a problem common to all structures: “Every product that is long equity will have problems in the down market but compared to a direct investment [CPPI] still should be fine. I think the important thing is that the final client understands that [cash locking] could happen,” he said.
Investors in Lehmans structured products the world over have complained they had no idea how exposed they were to Lehmans credit risk. It does not exercise the imagination too much to envisage investors complaining they did not understand they were being sold a product capable of being locked into cash mid term.
Perhaps for this reason, and also because of the market’s new-found emphasis on service and the management of structured products on a portfolio basis, we might expect to see providers of CPPI products offering rollovers and restructuring in the not-too-distant future.