The European structured products association is seeking clarity around the EU’s upcoming retail investment strategy and the application of a market wide ESG methodology as it continues to support educational efforts and new initiatives from national level trade associations.
The European Commission’s continues its review of the Sustainable Finance Disclosure Regulation (SFDR) and the implementation of its EU Retail Investment Strategy (RIS) which will introduce a limited inducement ban, pricing benchmarks, ‘best-interest’ tests and an unfeasible timeline. With that in mind, SRP caught up with Thomas Wulf (pictured), secretary general of the European Structured Investment Products Association (Eusipa) to discuss the agenda for the European industry for 2024 and some of the initiatives driven by domestic trade bodies.
Many regulators in the EU do already heavily police their retail banking business. They do not see a need for EU gold-plating and frankly, neither do we - Thomas Wulf
According to Wulf, the European structured products industry’s position and that of the financial sector in general on the EU’s retail investment strategy (RIS) proposed last year is that it “has been adopted by some governments like the French government, as well as several leading MEP in terms of rejecting a number of ideas”.
“[This includes] not only on inducement, but also the benchmarks and excessive overly granular value for money tests,” he said.
“We are not against value for money, of course. We are against seeking to document value for money through the adherence to European benchmarks because it's impossible to come up with benchmarks that are usable on a practical level across different countries.”
Eusipa’s position is that focusing benchmarks only on the cost level falls also short of seeing the whole picture.
“Numerous governments made that comment as well – because you must have performance cost ratio,” said Wulf. “The fact that a product is potentially more expensive, doesn't mean it's less profitable. These points have come up in the discussion so far, which is good.
“The RIS as such is heavily objected by many countries also for another reason. Many regulators in the EU do already heavily police their retail banking business. They do not see a need for EU gold-plating and frankly, neither do we,” he added.
ESG methodology
The ongoing discrepancies around the best approach to build a market wide ESG methodology that covers all investment products remains far from being resolved even within the European structured products industry.
“We still have different views on what the ideal approach is and may have to live with the fact that there is no such but various ones,” said Wulf. “It is important to say that none of the approaches we see excludes the other.”
Wulf noted that the two sides of the argument have its merits as including the derivatives delta into the calculation of an ESG contribution is a way of looking at it favoured by the French market and not doing it and using a segregated pool of assets held on the balance sheet of the issuer preferred by the German market is a different way of structuring your ESG exposure, which does however not exclude the delta approach.
“It's just a different way of doing it and choosing a different reference, so to speak,” Wulf said. “I do think that at one point, regulators will give us the clear views on what is the ultimately valid or more likeable approach from their side. That again may, also differ per national market.
“However, we must not forget that the question of admitting the derivative delta fundamentally is a discussion linked to the general topic of how derivatives held on balance, on an OTC level, are to be counted in or not in a Green Asset Ratio, or any equivalent, of the financial institution.”
This is not only about derivatives in products such as structured products, but also relevant to the broader discussion of what to do with derivative positions held by issuers of structured products and banks more generally.
“From a methodological point of view, these issues - product level consideration of derivatives and Green Asset Ratio inclusion of a derivative - are correlated, you cannot have a split views on this topic,” he said. “My guess is that once a decision is taken on OTC derivatives on balance, which may ultimately involve the central bank level rather than market regulators, the position is going to filter through to the discussion on whether the derivatives can have a relevance for quantifying the ESG contribution of structured products.”
New initiatives
Beyond the regulatory activity, Eusipa is also keeping a close eye on new developments driven by country associations such as the Swiss Structured products Association (SSPA) which launched a pension initiative to promote the use of structured products in the pension and retirement space.
One challenge is to make the population of institutional investors and the pension fund area aware of the structured products offering - Thomas Wulf
“The pension gap is a macroeconomic challenge of first order within all OECD markets,” said Wulf. “We all need to find smart ways to cover this gap which includes, at least partially, a stronger capital markets exposure. Everyone's been preaching that, and the investment community but also the legislator and regulator round in the EU need to live up to that promise.
“We are not only speaking here about the individual pension product buyer but also more broadly the institutional investment approach set out by the pension funds themselves.”
According to Wulf, structured products have, for both types of these customers, something unique to offer in terms of “giving a buffered, somewhat protected exposure to equity markets while having a moderate while also predictable yield”.
“That is a combination that is ideal for pension fund managers, or more in general for institutional investment managers of any sorts,” he said. “One challenge is to make the population of institutional investors and the pension fund area aware of the structured products offering.”
In Switzerland, the “very well calibrated” and “balanced” regulatory landscape has fostered clear conditions under which a financial instrument can be made part of the investable assets of the pension fund sector.
“The core condition is transparency on costs, which is something you must look at as a pension fund manager to the same extent you must look at the predictable yield that we offer through the annual coupons, but you would have to also look at how cost over time evolves in the product,” said Wulf, adding that the Swiss association has done a “fantastic job in preparing with the industry the granting of the official permission to market certain payoffs which have sufficient levels of cost transparency to the pension fund institutional buy-side which is a great leap forward”.
“However, in other markets, we do not have that clear pattern,” he added.
Switzerland is leading by example and providing a fine showcase to admit structured products payoffs in pension funds once the individual payoffs have been tested on the cost transparency.
However, cost transparency, while important, is not the only thing to consider for a pension fund asset.
“Now the hopes are that pension fund boards and their investment advisers start screening the various payoffs that fit in their portfolios,” said Wulf. “By and large my impression is, and that applies rather to the rest of Europe than to Switzerland that we need to (re-)educate part of the potential buyer population.”
Market dynamics
Wulf has a positive outlook for structured products in 2024 as the economic environment bodes well with what these products can offer.
“People have forgotten a little about the sideways markets because they have a very interesting bond market right now,” he said. “For years, equity was going through the roof, so there was for the overenthusiastic investor seemingly no need to look at alterative assets. Many were mostly interested in having direct exposure, even leveraged exposure to the equity markets, which our products also can offer.”
According to Wulf, investors that went for the direct exposure at some point ran into notable losses – “a story that is not much reported on”. However, even in the current environment of normalised interest rates investors can benefit from structured products with a limited upside but partial capital protection.
“Structured products are offering a protection against exactly such excessive volatility risks,” he said.
“Interest levels have returned to somewhat normal market levels. I'm not sure that there will be a huge shift in interest level going back to zero which you hear here and there being commented on. I don't see that happening. Geopolitical risk has returned, and it will stay for the foreseeable number of months, if not years, in the immediate vicinity of the European Union.
“This has also repercussions for us as for everyone, on a broader macro-economic scale including the rate evolution that is an expression of these risks,” Wulf said.
The expectation in the short-term going forward is that interest levels will stay at the current levels – “maybe slightly declining if the US makes the first move, which is not certain either”.
“If we do not have any more disruptive events in the geopolitical side, we have again markets which are horizontally moving in a number of sectors, maybe some sectors, like the tech sector now, going up again, because there is an investor confidence,” he said. “Obviously, we don’t know what we are going to see in the run up to the US elections. That may be another shock event for markets if Trump is going to get a second term.”
From a broader perspective, Eusipa sees a very interesting landscape for structured products, but it also believes that education continues to be at the top of the industry’s agenda.
“We need to re-educate however the clients on the many advantages our products can offer, including the already mentioned yield enhancement products – sidewards moving equity with structured products being one of the few tools which could provide a solid gain,” said Wulf, noting that people often make the same mistake when equity is slightly down or horizontal, and tech becomes too risky and go to bond markets.
“Instead of going straight to bonds or negotiating with their retail bank for a few basis points more, they can buy structured products with a five-year maturity, and get out with 5-6% annual return,” he said. “[This is] much more than you would get on a bank account and with a better sleep healthiness score that a direct exposure to stocks.”
The association, concluded Wulf, will continue to support educational initiatives and seek to expand to other markets where the local issuer population is willing to engage in a collective effort.