Structured product liquidity could lead to speculative trading, says former UK SPA chairman

A secondary market for selling retail structured products after they have launched is almost non-existent in the UK, but while advisers would like to reassure investors that they will able to sell products before maturity, industry participants at the UK Structured Products Association (SPA) conference in London this week warned of the possible side effects of such liquidity – including speculative trading or advisers being unprepared to explain how redemption prices are formulated.

Increased liquidity in structured products could lead to a rise in their use as speculative instruments rather than buy-to-hold investments, said Jamie Smith, former chairman of the UK SPA, during a panel session at the conference. "There might be clients who will potentially want to trade in and out of structured products because they're an investment tool, not because they need to pay a bill or they're saving for something," said Smith.

"So it might be that we need to think about product design and have products that are more suitable for active traders – not a capital-protected, six-year FTSE note, for example." Speculative traders are more likely to want products with a shorter term and a higher risk profile, and "[we should] bear in mind the secondary market from the start, not just as an added service," he said.

Other speakers at the conference said advances in technology are making the pricing and selling of structured products in the secondary market easier, but expressed different opinions about the extent of the market. "You can get retail structured products where you're locked in for the entire time – you can't trade those," said Ed Robinson, divisional director at investment management and financial planning firm Brewin Dolphin in London. "When we see secondary markets, typically there's a 1% bid-offer spread. Structured products have been stress-tested during the financial crisis and we found we could trade quite high volumes."

Another panellist disagreed: "It is a complete misnomer that once you're in [a retail structured product] you can't get out," said Thomas Hughes, operations manager at StructuredProductReview.com in Newcastle. "However, it is a portion of the market that hasn't been fully explored."

Even though the terms of a structured product do not change, its trading price could offer other opportunities to the investor if a liquid market is available, said one independent financial adviser (IFA). He gave the example of a six-year autocall that had not kicked out in year five. The product was due to deliver 60% at maturity if the FTSE 100 index was at 6,500 or above. With the market at 6,450, the product was being bid at about 130p, ie a 30% return on every £1 invested. The investor could wait to see if the FTSE would rise to get the higher return, and risk just getting capital back, or sell for 130p. "For a very small movement, you got an uplift of about 20% or a 20% fall in price," said the IFA. "The risk does change under the life cycle of the product and it has to be constantly monitored that it's still best for your client's risk appetite."

The industry is not yet capable of dealing with this pricing issue, according to Smith. "The secondary market hasn't really grown as rapidly as the primary market because structured products are designed to do defined things on a defined date," he said, adding that he is concerned about explaining the pricing to an investor if they wish to redeem early. "The customer will say: 'I've got this FTSE growth product and the market is up 10%, why can't I have my 110p now?' But it doesn't work like that.  The ability to explain why it doesn't work like that is another building block. To have access to the secondary market is another phase of development for us to go through."