In every continent, the structured products markets have taken a knock as a result of an equity market crash, regulatory restrictions or mis-selling scandal - usually all three. Crucially, in each case the markets have more than recovered, reports Kim Hunter.

European structurers may be surprised to learn that an informal SRP survey into the origins of the structured product industry showed the first batch of offerings came from the US, rather than their home continent. The nascent industry hit a hurdle almost as soon as it had emerged, however, when post-crash conditions met precarious regulatory foundations.

In 1987, the New York Times published an article about a 'Belgian dentist' investor, actually the president of a personnel agency, who had invested $10,000 in an equity-linked certificate of deposit issued by Chase Manhattan on the grounds that his 'spare' cash might produce better returns here than it did in the bank. Had the article been written a little more than a month later, after the October stock market crash, the picture would have been very different. Even in September, when it was actually written, the 'new trend in investing' it mentioned was being buffeted by the fund industry. By late October, investors were wary of equity-linked products, even those offering protection and particularly those involving derivatives, which, in the guise of portfolio insurance, were hailed as a major cause of the 1987 crash. The industry's commodity-linked products were also embroiled in a row about jurisdiction between the Commodities Futures Trading Commission and the Securities & Exchanges Commission that later spilled over into early attempts to launch 'participation' products on the US options exchanges.

Among the first certificates of deposit were Chase Manhattan's S&P500-linked Market Index Investment CD, launched in March 1987 with multiple maturities, a $1,000 minimum and choice of 100% and 104% minimum return levels. This was followed by Northern Trust's Company Stock Index Account, with similar terms and options, and the Wells Fargo Gold Market Certificate linked to the London price of gold. There were other commodity-linked products too: one early participant tells the story of a JPMorgan oil-linked structured product listed on Amex that fell foul of the SEC/CFTC divide. Wachovia's Richard Silva remembers working on another early commodities product while at Dean Witter - a Salomon Phibro Oil Trust product that had to be pulled due to regulatory uncertainty.

Silva says the early days were 'fun', though. He remembers early, but nonetheless post-1987 deals, including numerous warrant transactions: Nikkei puts in 1989, yen/deutschemark cross-currency warrants in 89/90 and US dollar index warrants around 1991. The first public equity-linked note he was involved with was the Stock Index Growth Notes issued by Republic of Austria in 1991, during the first gulf war. The SPX-linked product had a five-year term, 100% capital protection and 100% participation, and was  NYSE listed.

"[It was] the first publicly listed ELN, as I recall... it was definitely the first NYSE-listed note," he says. It had a transaction size of $100m, and was underwritten by Dean Witter Reynolds Inc and Goldman Sachs. Silva still has the tombstone ad. It is the only one he has ever saved.

Silva also remembers Vikram Pandit and Morgan Stanley creating a novel preferred stock alternative for corporate issuers, called Percs, not to be confused with the non-corporate synthetic offshoot Perqs, which came later. KMart, Sears and others did very large transactions, he says.
By 1993 Merrill had entered the business, courtesy of a former Bankers Trust team and Rick Sandulli from Dean Witter. The bank was 'blowing the cover off the market', says Silva, with SPX EPSs, which guaranteed a minimum return and paid equity upside, and Smart notes, which are still around today.

Investors with 100% participation in the S&P in March 1987 (Nigel Gardner, a Chase VP at the time, said a number of individuals had even opened million-dollar accounts) would not have needed their capital protection: the markets recovered very quickly from the 1987 crash, and rough calculations show a five-year product would have returned around 140% of initial capital. The $100,000 FDIC guarantee has also only recently come into its own with a resurgence in interest in CDs.

By October, a number of institutions, including Chase, First City Bancorporation of Texas and the Fleet National Bank were offering both bull and bear certificates. The Commodity Futures Trading Commission had already forced Wells Fargo to stop selling a gold certificate via a complaint in Federal court, but this did not stop First Chicago from launching a similar product, while banks lobbied the courts over their right to issue not just capital-protected products, but mortgage-backed securities and other securitised products. In an echo of current European preoccupations, mutual fund trade association the Investment Company Institute had sued Chase, arguing that its new certificate violated the Glass-Steagall Act, designed to prevent banks from underwriting and selling securities.

On 6 October, Shearson Lehman Brothers launched a national programme for bull and bear certificates, Performance Plus, which was used by 75 banks before it was suspended in the wake of the crash. Buyers could lock in a specific return once during the life of the CD, for example, a 12% rise after three months, in exchange for a reduction in the final participation.

Keith Styrcula, the chairman of the US structured products association, traces the more recent surge in structured products to the market break of 2000, when structured products had a starring role in repairing devastated portfolios following the dot.com meltdown, he says. "Volumes spiked year after year in double-digit growth, particularly after the collar [single stock monetisation] business began to fade and the primary derivatives-based investment category became structured products," he says. "A great deal of derivatives talent shifted... to the structured products business, as even the European firms began establishing a beachhead in the US during that time."

Europe
The origins of the European market also lie in 1987, but this time in the risk aversion that arose in the aftermath of the 1987 crash. There was a slow start on the continent, and the faster-growing British market took a tumble in 2002 during the 'precipice bond scandal': the income product market disappeared almost overnight, taking half the market's volume with it, when investors in reverse convertibles with a 2:1 downside realised losses on their portfolios during the stock market rout of that year.

Bankers and product providers have dug deep into their archives to provide us with the details of their first ever structured products. SRP's MD remembers structuring his first insurance-wrapped product back in 1990 while at Midland Bank, a claim to fame beaten, anecdotally at least, by Alan Williams, who claims a very early product, launched in 1989 just before he established Manor Park. The product was wrapped in a retail pension structure, a (L&G) Trustee Investment Bond, he says, though we have no literature for the product.

Another early UK participant, Mark Ellis, was working in Bankers Trust when they put together a couple of very early, though undated, deals for Irish Life and Midland Life -probably in the summer of 1990, he says. The zero plus call option structures were wrapped in a life policy and sold to retail investors. They were successful 'by any market standards'. People operating within the nascent industry were 'very excited' by the prospects of the products, he says. "The early [products] were all launched by entities that came back for more. I believe that most of them are still issuing in one form or another."

UBS's European head of equity derivatives, Vito Schiro, staked a claim to be among the first issuers in continental Europe with Guaranteed Return on Investments Units auf den SMI, launched by UBS forerunner Swiss Bank Corp in January 1991, some six months later than Ellis's recollections.

For its part, Société Genéralé claims to have launched the first European structured fund. Franvalor Variance was launched through the SG retail network in 1991, with subscriptions open until March 1992. The capital-guaranteed fund was linked to the performance of France's Cac40.

"Other banks had launched capital-guaranteed products, but they didn't use a fund format," says Ron Oman, head of communications for the global equities and derivatives solutions business at SGCIB. "The idea that retail networks could be important distributors of equity derivatives through funds was very new. We accessed new clients with low competition because US banks were targeting asset managers as clients, not retail networks," he says.

Asia
Hong Kong observers tell us the bursting of the tech bubble combined with falling interest rates to provided the catalyst for the development of the structured products market. Hong Kong's first guaranteed fund - an actuarial based insurance product - was launched in 2000. It was followed almost immediately, courtesy of Alfred Yip, who went on to lead HSBC quant manager Sinopia, by a tech stocks-linked product hedged by HSBC's asset manager. BNP Paribas was involved in the creation of both these funds.

The need for income soon prevailed. "BNPP pioneered product that offered a high fixed coupon and then subsequent variable coupons based on the underlying, always with principal protection and starting to attract money from term deposits," says Henry Pang, head of structured products at the French bank. "Between 2001 and 2004, there was a lot of innovation in Asia, thanks to premium constraints, which led to path-dependent options to offer better efficiency between payout and the premium," he adds.

Peculiarly, the quiet resulting from the Sars virus in 2003 prompted one such R&D push: as interest rates fell further and the yield curve flattened, maturities lengthened to seven and eight years; knockouts, first on Libor accruals and then with equity underlyings, were used to generate shorter terms.

Around this time, says Pang, BNPP invented the 'springboard' to boost coupons by selling a series of puts. "The aim was to find an equilibrium between the coupon value and the early termination probability," he says. The bank also pioneered the use of the best-of option in the Asian retail markets.

Between 2005 and 2007/8, as equity markets moved into a bullish environment, products were used for yield enhancement and the evolution into multi-asset products in 2005-6 laid the foundation for the structured products boom in 2007-8.

The rest is not so much history as current experience. Maturing worst-of products were already knocking confidence among some Asian investors. It was then decimated by the Lehman crisis. Asian sales volume is down up to 37% from its peak, rising to around 50% in some bull markets and possibly as much as 80% in gung-ho Hong Kong. But, as the experience of earlier knockbacks in other continents shows - the precipice bond mis-selling scandal in the UK, the pause in the early US market - such crises are healed by a combination of time and innovative solutions to genuine financial problems.

They may be healed also by a change in the attitude of its investors: the industry will have reached global maturity when its bull-focused end clients begin to demand longer term, simpler products that function as part of a broader portfolio.