Aggressive compliance requirements and a tarnished image, largely due to insufficient education, are the primary challenges facing US structured products dealers, according to panellists at the Broker-Dealer Expert Session: New Channels, Clients & Challenges discussion at SRP's 6th Annual Americas Wealth Management & Derivatives Conference 2017 in Boston on June 15.
Tiago Fernandes, global head of data, SRP, who moderated the panel, opened the discussion by pointing out that broker dealers are uniquely positioned to observe and identify the challenges before the wider structured products industry, and asked the panellists to outline the biggest obstacles they face.
"The biggest challenge that needs to be addressed by the industry is looking forward and not backwards, in focusing on providing added value for the investor," said Matt Ginsburg (pictured), vice president, head of retail sales & marketing, investment solutions group, Wells Fargo. "It's been said that structured products are sold, not bought, and this is largely true in commission-based distribution," Ginsburg said, adding that the way forward is in driving down costs and fees, and adding value to investors, and not necessarily to the brokers.
The challenge is how to deliver more value, Ginsburg argued, noting that the ETF sector has enjoyed significant interest not least because of cost reductions and improved transparency.
Price transparency, education, regulation and an active secondary market are, broadly, the biggest challenges facing the industry in the US, according to John Tesser, senior vice-president, head of structured products, JVB Financial Group. "One overarching, and more menacing, issue is that of wrappers, and the perception of complexity," Tesser said.
Mutual funds, and ETFs, are not much less complex than structured products, but the broad perception that a fund is a fund is quite the opposite, he argued. "The large array of wrappers that structured products are sold in create a sort of uncertainty and dilute educational efforts," Tesser said, noting that "the 'wrapper problem' has been persistent through the years and has prevented more wide scale distribution of structured products. "There's no easy solution to this problem, but it is something that we have to confront."
Jeffrey Miller, managing director, fixed income business development, Fifth Third Securities, argued that overly aggressive regulation is the primary issue weighing down the industry. "With a number of regulators, including the Sec, Finra, the Fed, and the DoL, all pulling their way creates a situation where distribution arrangements change on a monthly basis," Miller said, describing the environment as 'frustrating' and 'uniquely difficult'.
George Barbar, senior managing director, institutional sales & trading, Mesirow Financial, said that the biggest challenge is education, and argued that education that's been done over the past 20 years is getting to investors, and they are starting to understand the products more.
"A lot of that comes down to selling a theme, rather than a wrapper, or a structured product," Barbar said. "I really believe as we move forward as an industry, that it will turn less product specific, and more theme-specific," he added, pointing out to an earlier presentation at the SRP conference by Hardeep Walia, founder and managing director of US fintech firm Motif Capital.
"One of the biggest themes right now is rising interest rates, and Step Ups are an example of how you could execute upon a theme in a simple way via a structured product," Barbar said.
One of the most appealing aspects of structured products is the trade-off that is on offer, where you can give up some of the upside potential to have some protection against the downside, Ginsburg said. "Having these themes [like rising interest rates] and to superimpose on them the value added element of structured products, like trading off some upside for protection, and you could very clearly see a space going forward to the industry."
However, in order to hit double-digit growth, the industry would need organic growth of current structured products investors, as well as a new generation of buyers. To do that, the proposition would need to focus on the very basics, which indeed start with capital protection, Tesser argued. "In the past few years [in view of the interest rate environment] issuers have been largely unable to provide an attractive principal protection proposition," he said. "As rates start to rise, however, the industry can structure attractive products at this basic level to introduce to new clients, and initiate a new generation of buyers."
The panellists agreed that positive media coverage is also key, and highlighted the WSJ story from September, which they argued had taken data out of context which results in presenting CDs in a less positive manner.
An association would be a strong voice to hear in such situations, and it is something that has been discussed for a long time. However, one of the crucial issues in creating that is the sheer diversity of product types and wrappers, Ginsburg said. "There has been a lot of pressures from regulators, making the product change and morph, so the difficulty to create a representative body has been enormous."
Beyond regulation and education, one hurdle that most panellists agreed on is the issue of secondary liquidity.
"The biggest problem is secondary liquidity," Miller said, and Ginsburg argued that "nothing is more prominent than secondary pricing, and it is a 'critical' issue for many products and relationships.
The issue of the recently implemented DoL 'Fiduciary Rule', entered into force on June 9, 2017, which imposes a 'fiduciary' standard of accountability to essentially all financial advisers and brokers, much higher than that of a 'suitability' level.
"We are as ready for DoL as can be at this point in time," Ginsburg said.
Notably, Tesser argued that some financial advisers are using the new rule as a sales pitch, pointing out that they have been doing what the rule now requires for a long time. "This is my target audience now," Tesser said. "I find it phenomenal to be able to turn this new regulation to a positive use," he added, noting that the biggest issue with the rule, and with regulation in general, arises due to lack of clarity.
"When we know and can identify what we need to do, we do it well, and issues arise when there is opacity, and weak definitions leave us hanging," he said.
Miller underscored that the DoL has no capacity to enforce the new rule, and that mandate will fall to courts, where the critical first few cases will probably be cherry picked to go to most consumer-friendly courts and judgement, which will direct future conduct, could be skewed. "No matter what you do, you have little idea of how the whole thing will unfold, which is a scary thing for the industry," he said. "We just don't have the interpretation of this law."
Barbar agreed, noting that clarification, for clients, for products, is key. "Our job is to be there as a resource for advisers, and to help them execute the plan that they've agreed upon with their clients."
A member of the audience pointed out during the Q&A at the end of the discussion that a comparison could be drawn with the previously-mentioned WSJ article, where "a journalist decides what approach to take in investigating a story, because editors decide what the story is before that story is written". "Exchange the WSJ for a judge, and in view of the historic treatment of structured products in courts, you can see how DoL is an uncomfortable issue at the moment."
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