No More Driving Without Brakes

Listed structured products bring new flexibility for investors

Tim Bevan, Product Management & Development, London Stock Exchange
Originally published in the June/July 2005 issue

Buying a structured product without the flexibility to sell it has been likened to driving a car without any brakes – if the market turns against you, or circumstances change, you can be left speeding downhill with little control. The London Stock Exchange's recently-launched listed structured products platform seeks to change the way structured products are traded by providing a primary and a secondary market for both bespoke and standardised instruments, giving investors the option of applying the brakes.

The London Stock Exchange launched its listed structured products segment to an audience of more than 200 wealth managers in March this year. Existing structured products that had been hidden from view were given their own segment, so that the Exchange, alongside the banks that issue them, could provide better information on listed structured products and how they can be used.

Listed structured products are issued and marketed directly by investment banks using the Securitised Derivative wrapper that has been available since October 2002. Accessing the products is straightforward: they can be traded through brokers in exactly the same way as shares, settling through CREST on a T+3 basis. This means that no additional investment or infrastructure is required to access the products, and they can sit on a portfolio valuation alongside other investments. In addition, any monies due at expiry are automatically credited to the broker via their CREST account with no need for specific instructions.

The existence of a trading platform brings other cost efficiencies by bringing the issuing banks and end investor closer together. Without a distributor acting as intermediary there is no commission and marketing costs are minimal. There is direct competition between the four issuing banks (currently Goldman Sachs, SG, Dresdner Kleinwort Wasserstein and UBM) and because they all use the same wrapper price comparison is easy.

But what makes listed structured products so unique is that they combine the simplicity of trading exchange-listed instruments with the complete flexibility associated with traditional OTC or fund-based structured products. The products can be negotiated directly with the issuing bank, which then lists them and providestwo-way pricing. There are virtually no restrictions on the types of structured products that the issuing banks can create, and investors have freedom to choose the type of underlying, the expiry profile and risk structure.

Because the process is so straightforward, the listing of individual products carries a low marginal cost. This means that issuers are able to deliver bespoke products for indicative interest as low as £500,000 and can (from conception to listing) produce products in as little as 48 hours.

The platform already offers access to products based on a whole host of indices and commodities, including the Halifax House Price Index, the HRFX Hedge Fund Index, Brent Oil, gold and platinum. We expect to see the range expand as issuing banks respond to new market trends.

Once a product is listed, the rules ensure guaranteed two-way liquidity throughout the lifetime of the product, and in the majority of cases, continuous two way prices. With the ability to actively trade structured products, rather than only considering the payment profile at expiry, a new dimension enters structured products strategies. A portfolio's risk/reward profile can be actively managed, providing the flexibility to adjust to changing client needs and market trends throughout the lifespan of the product.

The different structures available are limited only by the client's investment needs. Recently we have seen accelerated trackers, bonus structures, capital protected and reverse trackers listed on the platform.

One example of the type of instrument that can be created is the Bonus Tracker structure, which is comparable to a fixed-term life product or insurance bonds. However, as with all listed structured products, Bonus Trackers are continuously priced throughout their lifetime with no early redemption penalties. The expiry profile is shown in the solid grey line in Figure 1 – as long as the underlying instrument remains within a predefined range, a minimum payout is made on expiry. If the underlying moves outside the range, it reverts to a standard tracker. If the underlying falls in value considerably and you no longer believe the defined range is achievable, the ability to trade out of this product and into a more appropriate one becomes a clear advantage over traditional structured products.

Already we have seen more than £500m in listed structured product trades executed at the London Stock Exchange and over the coming months we expect to see several more bespoke products listed as awareness grows that listed structured products offer opportunities for the serious asset manager as well as the high street investor.

Product Focus 1

Goldman Sachs FTSE 100 Accelerated Tracker (G950)

Accelerated trackers are growth-orientated structured products, giving additional upside performance whilst maintaining a 1:1 relationship on the downside in return for surrendering income streams related to the underlying asset.

The product is made up of a plain tracker and an at-the-money Call option – the dotted grey lines in the Figure 2 represent the payout profiles of these instruments individually, with the solid grey line denoting performance of the G950 Accelerated Tracker.

This particular Goldman Sachs product, based on the FTSE 100, offers 160% upside and 1:1 downside. It expires in September 2006, however it can be traded during normal market hours. To date the on-book spread has been maintained at 50 basis points in a size of approximately £100k.

Product Focus 2

DrKW HFRX Hedge Fund Index Tracker (D092) This Tracker directly tracks the HFRX Global Hedge Fund Index, which is designed to be representative of the overall hedge fund universe, comprising eight strategies (each of which could potentiallybe used separately to provide full exposure to the respective strategies).

The HFRX Tracker can be traded during normal market hours until it expires in October 2007, and carries the code D092 on the London Stock Exchange.

Product Focus 3

SG Brent Oil Tracker (SG02) This SG Tracker follows the Brent Oil future price – as each month's future expires, the reference price becomes the next nearest futures contract. This is a quanto product, so exchange rate risk is fully hedged out by the issuer, allowing the investor to achieve the same returns as the USD price of a barrel of Brent oil (before costs) irrespective of currency movements.

The tracker expires in June 2010, but as with all listed structured products can be traded during normal market hours. To date the on-book spread has been maintained at 50 basis points in a size of approximately £500k.

For comprehensive information on listed structured products go to: