Structured products appear to be entering a period of organic and rapid evolution in how they are marketed, packaged, created and regulated. Corresponding legislation has not been consistent with the growth and development of structured products.

Although this new legislation lacks uniformity, the call for reform is universal. The goal of these reforms is primarily to clarify the laws, which govern structured products in order to limit or nullify their contribution to systemic risk. One potential solution is to move as much as $600 trillion of over the counter derivatives into exchange markets. This would simplify oversight of investment bank functions.

The U.S. has responded to the call for more comprehensive legislation with the passage of the Wall Street and Reform and Consumer Protection Act in the U.S. House of Representatives. Before taking effect this law must pass through the Senate, but the potential passage is already creating discussion of future positive and negative effects. Some argue that the law will create an unnecessary burden, limiting flexibility and do more harm than good. Others claim that a new level of clarity that will minimize legal fees, decrease the cost of contracts and increase counterparty reliability will negate the costs of the new rigidity.
Retail structured products will avoid direct effect from legislation, but the financial backing that composes structured product notes will feel the effects of the legislation, ultimately altering the composition of structured products. An increase in minimum capital requirements on trading books of financial institutions in particular will indirectly alter the makeup of structured products. In 2009 the legislation to regulate credit rating agencies passed.

The E.U. hopes to unify its laws regarding various financial instruments, ranging from structured products, life wrappers, to funds. This is an effort to reach an agreement on how to regulate The Packaged Retail Investment Product (PRIP). It intends to beef up the authority of the Insurance Directive by creating more stringent UCITS-type conditions and develop new laws to cover structured products, which E.U. law still lacks the authority to regulate.

Demand for risk indicators for structured products is gaining steam and overruling the protests of some British Funds. Many claim that the variability of counterparties (the cliff edge risk) in structured products mitigates the efficacy of most regulatory instruments such as the risk indicators.

Collaboration in the creation of the new laws has been irregular. Numerous European trade associations, providers and distributors have provided input, but Britain has been relatively silent.

Contrasting views exist as well, claiming that increased clarity of all investments limits the freedom of investors willing to take higher risks for greater rewards. These views refer to the principle that increased predictability of returns on investment potentially diminishes the return.

The European Structured Investment Products Association, which represents the interests of retail trade entities in Austria, Germany, Italy and Switzerland, is concerned that required registration documentation and investors’ rights to withdraw if changes are made to original offers will create costly additional paperwork.

The structured Product industry in the U.K. has given little input to the discussion, with Barclays and RBS being the only firms to respond publicly. Independent British packagers remain mute on the subject. The UK Structured Product Association has also abstained from offering input.

Although discussions concerning PRIP have faced adversity, support for reform continues to accumulate in domestic forums.

Italy’s Consob hopes to adopt a two-page prospectus that details the information of all products for consumers. It is also lobbying the Insurance Regulator to take a similar approach towards improving consumer literacy.

Autorité des Marchés Financiers in France has increased its efforts to provide investor protection. It has created a new commission to track product trends, marketing and sales covering the full spectrum retail products to assist in this process.

These efforts are a result of the Lehman collapse, which created a demand for a new level of specificity concerning financial products.

Lehman’s collapse essentially pushed Arc Capital and Income, DRL and NDF into administration. Charges for an FSA review of the industry compensation scheme developed in the wake of Lehman’s failure.

The FSCS now anticipates a jump in structured product claims to 1,600 in 2009/2010, and in next tax year a further 2,200 could arise. A £20m levy on intermediaries to cover compensation costs has been announced by the FSCS.

Product marketing and sales has dominated the focus of the FSA review. Although there has been an increase in providing the names of counterparties as well as description of their risk, the advice offered is often still unsuitable or unclear.

Criticisms of the review are rapidly developing. One of these criticisms is that the FSA excluded unregulated own-brand and white-label structured notes from its analysis. This exception cultivated particular consternation considering the extent of their sale by bank and building society branches. The distinction between Structured Deposits and SIPPs is a result of labeling Structured Deposits as cash-based, changing the guiding principles.

This is part of a broader collection of complaints, arguing that the FSA’s guiding and regulatory practices fail to grasp the big picture. Structured Products and similar investments such as, unit trusts and the arbitrary distinction between them is causing grumbling in the financial community because the distinction lies in a demand for Capital at Risk documents for Structured Products.

Guidance laws, demanding that information about the products be given to investors also presents problems because they may trample on a company’s already effective practices of information dissemination.

Other problems arise from unclear distinctions by the FSA as well. New funds that invest in structured products must provide a warning. However, equity-based mutual funds do not have to give the warning. Lacking parity, the guidelines inadequately react to problems of compensation. Loopholes, which providers can exploit, continue to exist, resulting in an unfair burden of payment falling on the adviser.

Wealth managers and members of the private banking community are having a difficult time adapting their practices to the new protocol, creating worry that it will affect existing and future business models in negative way.

Each of these issues leads to the overlying problem that FSA guidelines are attempting to force a complex product into an overly simple solution.

Although grumblings about the new guidelines exist in the financial community, the recent reforms will guarantee a greater awareness of structured products, demanding that all financial advisers understand the product’s essence as well as in it is profitable investment for their clients.