Structured product providers braced for RDR

Independent providers of structured products could see biggest threat to business model yet as sector comes under RDR spotlight

Independent structured product providers could see the biggest shake up of their business model to date as they respond to RDR.

The sector has already been the focus of attention following the bankruptcy of Lehman Brothers, which acted as guarantor on many of the structures, and the collapse of` companies such as Arc Capital & Income and NDF.

However, the surprise decision by boutique provider Blue Sky Asset Management to call time on its independence has prompted a new debate about the future of the sector.

Blue Sky managing director Chris Taylor has said the sale to Incapital Europe was prompted by his belief the independent model is not sustainable.

His argument is the majority of smaller providers lack what he has coined the four Cs: credentials, capabilities, controls, and capital, though he says Blue Sky only lacked the latter.

This has raised eyebrows among many in the market as Taylor has previously been one of the most vocal proponents of independent structured product providers.

But the tie-up is illustrative of the changes taking place in the industry. As it emerges from the two rocky years post Lehman Brothers, confidence is up, sales are booming and providers are looking at how to build a business ready for the new challenges of RDR.

Incapital Europe’s buyout of Blue Sky gives Taylor and his team greater capital, support and distribution, but has he been too harsh in writing off independents?

The demise of Arc and NDFA would suggest not, but companies such as Meteor Asset Management and Jubilee Financial Products continue to trade.

Adrian Neave, managing director of Gilliat Financial Solutions, which is owned by Arbuthnot Banking Group, believes there remains a role for the boutiques.

“Do I think independents can survive? Absolutely. If you look at the way products are structured, the independent is not the hedge provider, and the assets are hedged by the counterparty. And as most providers outsource their administration, the clients are not exposed to the credit rating of the provider.

“However, small is not good if you have a problem with mis-selling,” he adds.

Marc Chamberlain, Morgan Stanley executive director, says independents are an integral part of the industry.

“Many of the non-bank issuers realise the problems of the past and so have a diversification of business lines,” he says.

“Independents play a useful part in the marketplace by employing innovative solutions to structured products. That nimbleness should not be exterminated from the market.”

Meteor managing director Graham Devile says he learned the importance of having a strong capital base from his experience at EuroLife.

“We take upfront commission, but from day one we have reserved some of that commission for running costs,” he says.

“The aim is to have a situation where if you have not written any new business you can still be self-sufficient.

“We are also expanding into funds for stability. It gives us income stream diversification so if, for any reason, investors stop wanting structured products, we will still be here,” he adds.

Ian Lowes, managing director of Lowes Financial Management and founder of

StructuredProductReview.com, argues boutique structured investment groups are just as feasible as independent IFAs or fund managers.

“I have seen independents produce better products than the banks thanks to their timing and flexibility,” he says.

“It is true no small or medium sized firm will survive gross negligence, but where do we draw this line. Should all IFAs be under a network? Is there no room for independent fund managers?”

But Taylor is emphatic: “Can there be a bigger indictment of the small independent model than one of the leading smaller players holding their hands up and saying ‘we don’t think this works?’”

Whatever the views on whether smaller structured product providers can survive, RDR is creating new challenges.

Under RDR, structured product providers will need to provide a breakdown of costs, though debate remains about the required level of detail.

Gilliat’s Neave believes RDR will make it more difficult to sell structured products.

“I think it is a great shame. Although the headline rate on a structured product will increase, advisers will have to explain that the fees will have to come out of that and it is not what they will receive,” he says.

“I understand where the regulator is coming from, but it could lead to a situation where IFAs say they cannot afford to advise smaller clients.”

Gary Dale, Investec’s head of intermediary sales, is even more pessimistic on its impact for structured investment boutiques.

“The small providers will die. Post RDR, all the fees will be explicit and an independent will have to show the costs for paying the hedging bank, its marketing and take its own slice. Any IFA that sees that will question why they and their client should pay for all these different parts,” he says.

That is not the view of Devile, who believes the new regulation could inadvertently boost sales.

“Perversely, RDR could make structured products look more attractive,” he says.

“It will lead to factory gate pricing, which means you have an increase in the headline rate.

“For example, under the current system if you have an autocall paying 10%, fees and commission are charged separately.

“With factory gate pricing under RDR, the autocall will pay 13%. Although fees will be taken out of this, it actually looks more attractive,” he adds.

However, Lowes believes both these arguments are too simplistic.

“Those that think the breakdown of pricing will put investors off will be disappointed,” he says.

“The breakdown will show about 1% for distribution, 2% for the admin and 3% for adviser costs. This compares well with a unit trust especially when taken over a five- or six-year term.”

“Plus, there will be a limit to how much detail is shown. When I buy a tin of beans at Tesco, I do not know or need to know how much of that goes to the checkout girl, and it will be a similar situation for structured products.”

The UK Structured Product Association believes the industry is ready for these challenges.

“The structured products industry is evolving to fit into the new distribution and advice environment that RDR will bring. Structures are increasingly popular and this is partly because of the speed that providers can react to client demand from retail, institutional and discretionary clients,” it says.