Nordic horizons

The Structured Products Nordic Region Conference in Stockholm was held the day after the Swedish central bank announced that it would be taking a EUR3 billion loan from the European Central Bank, to insure financial stability in the face of the region's heavy exposure to the Baltic states. Despite a less than rosy outlook, cautious optimism prevailed as providers detailed how to survive the downturn and a stricter regulatory environment.

The Nordic region has been plagued by uncertainty about which way the regulators will turn, particularly after Norwegian regulator Kreditillysnet closed down its retail market 14 months ago. Kreditillysnet decided that a combination of debt and derivatives was unsuitable for retail clients, due in part to some unsavoury marketing practices by distributors and heavy losses sustained by retail clients. "I think Norway's position is extreme, but it is not impossible that others might drift that way," said David Brunning, managing director of UK retail distribution firm Brunning Newman Houghton. "Regulators are not our friends, and they are not there to represent the industry," said Brunning. Many of the developments enshrined in the UK's Treating Customers Fairly principles may well be adopted in the Nordic region, he said.

One of the advantages of European regulation is that it follows a more principles-based approach, rather than the US style which focuses on rules, as Antti Parviainen, chairman of the Finnish Structured Products Association (FSPA) explained. "The 'tick the box' method means you might miss the elephant in the room," said Parviainen, citing the Madoff hedge fund fraud as an example.

The Finnish Financial Services Authority published a statement on June 10, the day before the conference, declaring that the marketing material and risk disclosure on index-linked bonds was insufficient. The announcement was similar to a release the previous year which was published on the back of an industry audit. The FSPA is planning to discuss the disclosure rules with the authority. "I think the regulation that has already happened is sufficient," said Parviainen.

Self-regulation is particularly efficient, as market participants have the best access to the latest innovations and information, he said. Parviainen argued that as misconduct will have a negative effect on the market as a whole, it will provide an incentive for market participants to regulate themselves in a more prudent fashion. He put the case for a tripartite approach, combining principles-based regulation from the European Union, direction from the local financial services authority which takes into account different local practices, and finally industry self-regulation to introduce market practices and standards. The FSPA has been playing its own role in this by issuing guidelines and restrictions to its members, creating common market standards and educating the public, media and investors about structured products amongst other initiatives.

Back to basics

In common with structured products markets worldwide, the Nordic market has made a move "back to basics", said Steven Goldin, vice-president of portfolio services at Standard & Poor's. "There was an overproductisation of underlyings as everyone joined the index business," said Goldin. "When the Risk Stabilised Symbiosis Enhanced Strategy Index was launched, the saturation point on innovation had probably been reached."

Despite the noise over dwindling dividends, Goldin said that significant dividend suspensions have been a phenomenon specific to the financial sector. The related indexes have actually performed well, and despite market perceptions, dividends showed a net increase across all sectors of the market in 2008. Assets under management for exchange-traded funds linked to the S&P Dividend Investor series have increased by over US$1 billion over the past 12 months, while 35 product issuers and end-distributor clients have expressed interest in dividend investing in 2009, said Goldin.

The other back-to-basics trend is a reversion to home markets, which has seen Nordic investors looking to local indexes and shares, such as Carlsberg, Nokia, Norsk Hydro and Handelsbanken, said Goldin.

Structured products distributors are seeing the same trend, as indicated by the keynote speaker, Thomas Bratt from Garantum Fondkommission. Swedish investors have been hesitant to buy anything except for Nokia (the Finnish mobile phone company) said Bratt, which Garantum Fondkommission has been packaging into autocallables, although it has also structured a kick-out note based on European real estate.

Today's structuring conditions are a far cry from the markets of 2005, when it was possible to arrange an index-linked bond that gave 170% participation in the OMX index with only 10-12% risk, including fees. Bratt described October 2008 as "the most challenging market conditions ever", not least because of record wide credit spreads, extreme volatility and falling interest rates, but also due to clients' extreme risk aversion. In April 2009, Garantum Fondkommission addressed the latter by offering insurance against default on all UBS products that the distributor sold. For each SKr100 invested, SKr120 is deposited into a segregated account and invested in low-risk hedge funds. Should a default occur, the hedge fund positions will be liquidated to pay the client.

One of the benefits of the panic over counterparty risk has been the increase in business for external credit issuers, especially in the US, and Swedish agencies have been remarkably successful at winning this business. Swedish Export Credit (SEC), which carries a triple A credit rating, has issued an average of three to four structures a day, said Per Akerlind, chief financial officer of the export credit agency. "It's sad to hear that investors are not paying attention to the credit risk that they get with a note," said Akerlind. During the roundtable session, other providers applauded SEC for buying its paper back at the same spread. "I wish more issuers were like SEC," said James Chu, managing director and chief investment officer at Blue Sky Asset Management.

A niche has been left for some kind of secure backing because, whereas in other regions deposit-based structures have been popular because of their coverage under government compensation schemes, in the Nordics there is no equivalent. "I don't think there is really a demand for this in Sweden, and I don't see it coming," said Gustav Axehult, an independent financial adviser with Soderberg and Partners. One delegate was quick to differ, insisting that there is a demand for structured deposits from investors.

The future of the structured products market depends on how investors comprehend risk and loss. "Suffering loss is much worse than the joy you get from a gain," said Mikael Axelsson, chief executive of Oak Capital. With this in mind, a protected structured product is designed along the lines that the human mind works - with downside protection and an upside cap.

The new awareness of risk has affected investor behaviour and product development, particularly the bias towards local underlyings and issuers, with 25% of products now linked to the Nordics, against only 5% linked to Brazil, Russia, India and China. Investors are seeking safety, but not necessarily simplicity, said Axelsson, while risk appetite will return in the wake of the crisis. "Hopefully we are moving towards a situation like 2006/2007, but it will take some time to get there."