Product Manufacturing for Wealth ManagersMarch 31, 2016 - 13:27
One of the consequences of the FCA's March 2015 review of structured products is an increased focus on 'product manufacturing'. This is particularly relevant for any business that has advised clients that use structured products. Most advised clients will be 'retail' regardless of how much money they have.
There are only three types of investor according to the FCA. The definition of a retail client is extraordinarily broad, and covers anyone who is not an 'eligible counterparty' or a 'professional investor'. HNW investors are almost certainly 'retail' clients regardless of how much money they have, or how 'sophisticated' they are. As such any product that is offered to these clients needs to have been created and developed by a product manufacturer, and this product manufacturer needs to have gone through the required steps by the FCA. Broadly these can be summarised as follows:
- Identify the target client or clients. What are they looking for, income, participation or a fixed return? What is their attitude to risk and capacity for loss? What markets do they want to be exposed to and what is their investment view? What liquidity do they need and what is their investment horizon?
- Develop and stress test products. The FCA has been highlighting the requirement to stress-test products in a real world environment for the last six years. The product manufacturer is required to see what returns the product may offer, to look at the risks that investors face and the returns that they may get, and to check that this is a match for the the target market. It is clear that neither a perfunctory back-test, nor a review of the implied probabilities from the trader's model is sufficient.
- Produce clear and fair materials and take responsibility for product distribution. Who is going to be offering this product, and how will it be distributed? The manufacturer needs to ensure that both the investor and the adviser have materials that describe the product. The materials are required not just to be a factual record of how the product works, but also to give investors an idea of the sort of returns that they may get and the risks that they face. The FCA have told us in person that what they want clients to understand is the things that will make the product work well and the market conditions that could lead to poor returns.
- Finally the product manufacturer needs to monitor the product over time. Is the product still appropriate for the target market? Is the price reasonable? (The FCA was particularly concerned that any secondary trading takes place at a fair price). Clients need to be updated on material changes in and risk-return throughout the life of the product.
In the good old days wealth managers, stockbrokers and family offices could work directly with issuing banks to shape products for their clients. Now this has become a regulated activity and wealth management firms and family offices need to consider if they have the tools, expertise and time to meet these obligations. If they do not, who is picking up this responsibility? It's not a role that can be left void. It is clear that the issuing banks are in general not assuming the role of product manufacturer when they send out an indicative product shape, or even when they send out a term sheet for an issued product.
CUBE AS A PRODUCT MANUFACTURER
At CUBE we can take on this role ourselves or work with wealth managers and family offices that want to be a product manufacturer. Our product development process, stress testing, product approval and fair value calculations means that we are able to meet the FCA requirements.
Where required we can create retail facing materials and supplementary information for advisers. We can monitor products over time and provide the required supervision of secondary market trading.
IDENTIFY TARGET MARKET
We work with our partners to define the target clients and what they want.
- We have a standard form that we use to initiate the development process.
- The product initiation process defines all.
STRESS TEST PRODUCT
We can use our pricing tool to develop indicative product ideas, and then stress test these ideas to see if they meet the clients requirements.
The stress test is particularly important. We use multiple scenarios to calculate the chances of each event and the associated annualised return. The scenarios include our standard stress test, the historic back-test, the PRIPS standard stress test and the three UK SPA scenarios.
We then use the information from the stress tests to calculate a range of risk numbers and a variety of return calculations.
- Most investors use volatility as a measure of risk, we calculate a measure of average shortfall, expected loss, chance of loss, chance of barrier breach and a number of other measures of risk. The range of risk calculations means that we can map products onto a distributers risk scale.
- We prefer to use CAGR as a measure of return, we also calculate an Arithmetic Return or IRR, conditional gain and a number of other return measures.
If required we can arrange for different banks to provide trading levels, and help evaluate choose between one issuer and anotherUsers are able to upload products themselves to the stress-test system, or we can upload products.
- Users can download a PDF summarising the analysis
- Products are uploaded as indicative product to the main product list
- The system stores each iteration so maintaining an audit trail
We have a number of value-for-money tests for and other tests to check that the product offers an attractive risk/return versus the benchmark cash/risk asset efficient frontier. These feed into our product approval process.
We have developed an integrated suite of product documentation to facilitate the promotion and distribution of products.
- Indicative term sheets offer pre-issue summary details and risk/return analysis that can be shared with investors prior to committing to a trade to gauge interest.
- Once the decision to issue the product has been made we can create a retail client-facing brochure. This document fleshes out the detail of the product, the underlying assets, the issuer, the risk and return analysis and the other risks that investors face.
- Advisers have access to the Investment Product Research website that offers detailed and comprehensive analysis of each product throughout the product lifecycle. IPR offers a range of other tools that allow wealth managers and their support teams to monitor products.
- End investor accessibility to brochures, term sheets and updated analysis through www.cubeinvesting.com or through your site via a simple data link
David has been involved in equity derivatives, equity structuring and the structured product market for over 25 years. Before setting up CUBE in 2013 David worked at J.P. Morgan, Barclays and RBS. David has worked with and for retail product providers, discretionary managers and institutional investors.