Incapital md and co-head of structured products group Brian Jones believes his is the first group in the US to have a multi-provider structured products platform selling through a national web of 500 broker dealers, the American equivalent of an IFA. In that, it is the closest thing the US has to a UK-style product provider, the main difference perhaps being the tendency to co-brand products with the structuring bank.
From across the Atlantic it looks very much like the right model, at the right time, in the right place. US structured product sales grew 200% in 2003, and although the growth rate cooled in 2004’s uncertain equity environment, the market is poised for the next expansionary wave. Structuring banks are rushing in to service the fast-growing market. Soc Gen and ABN Amro arrived two years ago, followed soon after by Rabobank and Barclays Capital. Now BNP Paribas and JP Morgan are expanding their services beyond their own remit, says Jones.
Incapital itself is distributing some $200-300m of product per annum at the moment, and regards itself as having only just begun. Jones and co-head Charlie O’Flaherty came to Incapital fourteen months ago from Nationwide Securities, a predominantly mortgage house where they had built up a structured products enclave.
“Incapital is unique in the US in its history as a dedicated retail distributor of fixed income products. Some of its senior people come from other broker dealer firms. It’s a really good fit,” says Jones. The company considers itself the premier corporate retail note writer in the US. It has sold over $35bn in its weekly corporate bond programme, InterNotes, which it has also rolled out to Europe.
Grafting structured products onto that history has not been a difficult exercise. The company is known for its high-tech approach to servicing the retail bond market, and Jones and Flaherty were able to exploit those IT skills and the firm’s proprietary order entry system Incapnet for the structured products platform, Linx. The platform sends out 30,000 weekly Financial Adviser emails, and has 11,000 registered users of its web site, and links to other distribution platforms. It makes its living from a small slice of the margin built into the product.
Jones believes it is not just its unique position sitting between banks on the one hand and broker dealers on the other that sets the company apart, but also the way it services both those elements. “Before we came along there were only a few distributors tied to a single provider bank. We have some strong relationships, but our platform is multi-issuer. Banks have to adhere to particular standards to get onto the platform: they have to be service oriented, they have to be prepared to make a consistent offering, so that the trader and broker know they have an on-going product line, and they have to provide secondary market liquidity,” says Jones.
Jones says structured products are one of the few areas of US financial services where it makes sense to have a firm negotiate the space between end distributor and producer. “All the issuers have big exposure in Europe, and have been really successful there,” says Jones. “But they do not necessarily understand the US market. We tell them what is necessary, and link them to the broker dealer.”
Incapital has no direct competitors, because the dominant US business model is of a tie to a single provider. LaSalle, for example, is a broker dealer tied to ABN Amro. Countrywide still has a structured products desk, which is tied to SocGen. Wirehouses like CitiGroup and Merrills only occasionally expand from internal to external distribution, says Jones. Incapital, on the other hand, lists a raft of banks with whom it works: two of its top-three provider banks – Rabobank and Barclays Capital – are relative newcomers to the market. Soc Gen has a longer US history, and is joined in the top five by HSBC and BNP Paribas.
The rise of structured products in the US has occurred at a time of heightened awareness of compliance issues, says Jones. It is therefore as crucial to take the best products from the best providers, and to ensure they provide secondary market liquidity as it is to educate the broker dealer community in the product set.
Simple and Consistent Products
As in the UK, products must be simple, and offerings consistent. The dominant wrapper is a simple fixed income note, which in the case of a reverse convertible can have the returns from the option portion reclassified to qualify for capital gains tax treatment. Term varies from a standard one-year for reverse convertibles to between five and ten years for capital-protected products, with a smattering of three-year offerings.
Today, the biggest selling product by head and shoulders, says Jones, is the one-year reverse convertible on a single equity, a reversal of fortunes from three years ago when the fully capital-protected product linked to a US index was dominant. Incapital launches between six and eight reverse converts a month, many of which are sold in 10-20 bond trades ($1000 par), with some trades stretching to $2-3m.
All Incapital’s reverse convertibles have soft protection, usually 30%, but sometimes 50%, or 10% on a blue-chip stock. Jones regards that as a USP for the company, and expects the downside protection theme to be further developed as 2005 goes by. Nevertheless, he says, the US retail market’s familiarity with single stock investing means buyers of structured products are more aware of and willing to take downside risk.
As rates tick up and the zero becomes cheaper, the product set will change, says Jones. The capital-protected note is already coming back: at the moment the market is buying around 75% reverse converts; 25% cap protected products, a ratio that will move to something more like 60/40 in favour of reverse converts, he predicts. Underlyings to capital-protected offerings are also straying from US indices into FX and commodities.
Product innovations for 2005 include broader underlyings, and trigger notes and equity-linked certificates of deposit to satisfy the demand for annual income.
Incapital’s own plans span national borders. At home, there are still some broker dealers not yet reached, and growing demand for bespoke deals, usually a reverse convertible on a specific name, from everybody from the registered broker dealer to the small money manager.
What about the London office? Might it also expand its product range to include structured products? “It might,” laughs Jones, “particularly if the US market has a bad summer!”
