Sweden's IFA distribution model looking good for structured products

Structured products have once more proved a safe haven in a crisis for Swedish retail investors. When the Swedes got their first taste of how capital protection could help insulate them from market volatility back in 2002, independent financial advisers (IFAs) took the opportunity to gain a foothold in the emerging structured products market. Now they have an opportunity to use their expanding retail networks to grab even greater market share and give IFAs in other markets a strong example to try to emulate.

In many ways, the Swedish market is an ideal environment for sales of retail structured products. First, the country has a strong equity culture and has relatively high direct ownership of stocks. Second, there is a high savings rate and investors are familiar with the use of unit-linked insurance products within Ucits wrappers (collective funds established under the European Union's Undertakings for Collective Investment in Transferable Securities III directive) as a savings tool. Once it became possible to include structured products and other securities in these insurance wrappers about 10 years ago, it was relatively easy for investors to understand how the products worked.

"Giving investment advice to retail investors was not a regulated activity in Sweden until the implementation of the Markets in Financial Instruments Directive (Mifid) in 2007. So in the early 2000s there was an industry of insurance intermediaries that were already focused on advising on Ucits-linked insurance products. Those advisers were simply able to start selling structured products in the same wrapper to their existing customer base," says Anders Malm, a capital markets and securities lawyer at law firm Oreum Advokatbyrå in Stockholm.

The backbone of the market from the start has been three-to-five-year products with capital guarantees, which Sweden's big retail banks, particularly Handelsbanken and Swedbank, had started selling to their own networks of clients before the stock market crash in 2002. "IFAs found that a lot of clients had bought structured products from the banks before the previous equity market crisis and had seen that they performed well in volatile market conditions. The opportunity to invest in equity-linked structures with capital protection is fundamentally attractive to the typical Swedish investor," says Joel Gronberg, a partner at Söderberg & Partners in London, which has become one of the country's leading IFAs over the past six years with about 300 advisers.

Most of the big retail banks have tended to focus on the exclusive distribution of their products to their own network of clients in order to drive traffic to their branches. This created an opportunity for independent brokers such as Erik Penser and HQ and foreign banks to start creating products for Swedish retail investors, as well as their institutional clients, which could be distributed via the country's expanding network of IFAs.

Structured product offerings by Sweden's four main retail banks - Handelsbanken, Nordea, SEB and Swedbank - peaked at $5.5 billion in 2007. This compared with high points of $3.2 billion in offerings by independent arrangers and $2.7 billion in offerings by major foreign banks in the same year, according to bank data compiled from clearing and settlement services firm Euroclear and VPC, the Swedish Central Securities Depository.

"Swedish investors tend to buy three-to-five-year products. So in 2007 you had the combination of people redeeming products bought around 2002 and buying new products, early redemptions in order to lock in profits as well as new money," says Gronberg. "Then, in 2008 and 2009, there was little activity because few products were in profit and many had been redeemed early."

The IFA route

Though overall structured product sales have not regained their peak of 2007, the market's changing distribution structure has favoured some players more than others. For example, the value of issues by foreign banks was $2.5 billion last year, only 11% below the 2007 peak. This compares with a 40% drop in the value of issues by independent arrangers to $1.9 billion over the same period and a 50% drop by the Swedish retail banks to $2.8 billion.

The particularly steep slump in offerings by Sweden's local banks may reflect the fact that while the Swedish banks have tended to stick to selling products through their branches, it is the IFA distribution model that has helped to support retail sales over the past few years. As a result, some issuers that have focused on IFA distribution have been able to increase their market share.

"Sales of structured products have been stronger in Sweden than in some other markets over the past few years. What has been different is the growth in distribution through IFAs, which are often self-employed or work for small organisations and are more incentivised to sell the products than people in bank branches," says a structured products banker in London.

One independent broker that doubled its issuance of structured products to nearly $1 billion through the financial crisis using IFA distribution is Garantum, now the largest independent arranger and third-largest overall.

Similarly, Royal Bank of Scotland was also quick to spot an opportunity to increase its presence in the Swedish market on the back of this trend. Five years ago it formed an exclusive co-operation agreement in relation to its retail structured products with SIP Nordic, a small independent broker dealer. This partnership has helped RBS to become the biggest foreign issuer of structured products in Sweden in just four years and second only to Handelsbanken overall. The UK bank increased its issuance from a notional value of $56 million in 2006 to $936 million last year, according to data from Euroclear/VPC.

Education of IFAs at the RBS Academy over the past five years has been an important part of the success of the partnership. RBS brings Swedish IFAs to London for seminars with international experts in the structured product market, something that SIP Nordic could not have provided on its own.

"We came to the conclusion that it would be beneficial for all parties to combine the resources of a big bank such as RBS with the experience of a local player," says Mathias Westling, co-head of the Nordic and Baltic region at RBS in London. "SIP Nordic has all the contact with the IFAs and investor community. They collect feedback about what types of investment product their clients prefer at the moment and we provide tailor-made solutions and the resources for the education of advisers."

Over the past three years, autocallable products have proved popular. These provide soft protection so that investors face the risk of losing money only on the worst-performing index in a basket of indexes. However, if all the underlyings are above their pre-set barrier levels then investors redeem their money plus a high coupon. "Autocallable products offer attractive terms and pricing in a volatile market, so they were popular over the past couple of years. But in recent months the terms haven't been as favourable, so investors are moving back towards traditional capital-guaranteed notes and warrants," says Westling.

New markets

The partnership between RBS and SIP Nordic spread to the UK in 2009, and to Finland and the US last year. The aim is to develop the business through IFA distribution like in Sweden: just over half the retail savings products sold in the UK and US are distributed via IFAs, according to data from Lipper FMI and the US Investment Company Institute. This compares favourably with continental Europe: in France and Germany the proportion is less than 10%, although a slow shift from respected banks to IFAs is also taking place in these markets.

That said, structured products account for a relatively small proportion of the retail savings markets in the UK and US. "In the US, there is double-digit growth in structured products. It is a small part of the retail market, but it is growing much faster than other product areas such as unit investment trusts, mutual funds and corporate bonds," says Mats Halvorsen, chief executive of SIP Nordic International in Stockholm.

"The US structured product market is growing faster than the UK because it is a less mature market and there has been less regulatory scrutiny. In the UK, there is still some uncertainty about what the regulator wants to achieve. But in recent, volatile years, there have been a lot of UK investors seeking alternatives to mutual funds or taking care of their own stock profiles," says Halvorsen.

The UK Financial Services Authority's investigation of the quality of advice given to consumers in relation to structured products backed by Lehman Brothers in 2007 and 2008 found that in 46% of cases the advice was unsuitable. The FSA was unable to arrive at a decision in a further 23% of cases as a result of inadequate customer records. The review also found that all the firms in the sample failed in some way to adequately disclose to customers the risk of investing in structured products, particularly counterparty risk.

There are a few other reasons why structured products might be a harder sell in the UK. "We believe a larger proportion of UK investors are income oriented and are looking for a fairly certain dividend or income stream as opposed to the focus on growth in Sweden. Structured products are a tough product for income investors because typically you give up the income now and you get an uncertain return on your capital at the end," says Gronberg.

"Structured products haven't been discredited in Sweden like they have in some markets because they were mainly equity-linked and capital protected - they have preserved investors' capital and gone up when the markets have gone up," he says. "They have been used a lot less to get coupon payments or to take risk. The problems have been with split-capital products where 10% of the return is guaranteed or there is a high-interest income. Wherever you have a high-interest income and an expected capital position or part-guaranteed capital position that later fails, you weaken trust in principal protection. In Sweden so far there haven't been many products with weak principal protection."

Regulatory change

Several ongoing investigations into retail products in Europe and in Sweden could affect the development of the Swedish IFA market, however. One of these is the European Union's consultation on Packaged Retail Investment Products (Prips), which gets to the crux of the Swedish Financial Supervisory Authority's concerns about the distinction between the marketing of structured products and providing investment advice.

In its response to the Prips consultation, the Swedish regulator stated: "Retail investors are more likely to be governed by the adviser's advice, rather than any information material provided to the investor. Accordingly, we believe that inconsistencies between advice provided to an investor and the contents of diverse information documents are a common problem from the investor protection point of view."

With the introduction of Mifid, some Swedish IFAs made the initial investment in becoming regulated investment firms offering advice, while some other firms decided to market investments to customers by only providing information about them rather than advice.

The Swedish FSA says it intends to clarify what constitutes advice (as opposed to marketing) in order to ensure that intermediaries are complying with the law. It is also investigating whether there is a conflict of interest whereby IFAs portraying themselves as independent receive remuneration from product providers.

"The Swedish regulator has always taken the attitude that retail investors should have a choice to invest in these products even though they can be complex or even risky. However, it is going to take harder stance on the supervision of the market. It has initiated an investigation into how products are launched, who the end investors are and whether their interests are being looked after. The inevitable outcome of all regulatory activity at different levels will be that IFAs will become regulated entities or act as the tied agents of a regulated firm," says Malm at Oreum Advokatbyrå.

Gronberg at Söderberg & Partners says that although structured products make up less than 10% of its business today, IFAs are keen to grow the non-pensions side of their business. "Twenty years ago there weren't any IFAs in Sweden, but today half the sales of life insurance products go through them," he says. "Now we have become a bigger sales channel the banks are more interested in engaging with us, and IFAs will develop into as important a channel for structured products as they are for life insurance," he says.