What are structured products?
Structured products are financial instruments designed to meet specific investment objectives by combining traditional assets (like bonds or deposits) with derivatives (such as options, swaps, or futures). Their redemption and their potential profit are linked to the performance of one or more underlying assets.
Depending on their desired goal, products can be designed to fit most market expectation (positive, stagnant, negative) and any risk profile.
Structured products also allow investors to get exposure to underlying assets usually complex to access to most investors, such as Credit Default swaps, commodities, Hedge Funds, risk premia and implicit assets classes such a volatility or correlation.
CATEGORIES
There are potentially an infinite number of Structured Products which can be devised for investors. The multitude of mechanisms available and possible combinations makes it possible to construct products for virtually all investor objectives and constraints. Eusipa intends to be a main supporter of the efforts for transparency and understandability of structured investment products. Thus, its members have agreed to set standards for a uniform categorization. These differentiate on a first level between Investment Products and Leverage Products. On a second level, the system consists of Capital Protected Products, Yield Enhancement Products, Participation Products, Reference Entity Products, Leverage Products with and without Knock-Out and Constant Leverage Products.
Capital Protected Products
Capital Protected Products offer full or partial protection of the nominal value (generally between 85% and 100%) at maturity, regardless of the performance of the underlying asset(s). They are popular among conservative investors seeking (partial) downside protection while still participating in potential market movements. It is crucial to note that the capital protection at maturity is only as strong as the financial health of the issuer. If the issuer defaults or becomes insolvent, the protection may no longer hold, putting the full investment at risk.
Yield Enhancement Products
Yield Enhancement Products are structured financial instruments designed to offer investors a higher return than traditional investments (such as bonds or deposits), while assuming moderate to high risk on the capital. Unlike capital-protected products, these products do not systematically protect the entire capital invested, even though they often provide conditional protection mechanisms such as activation barriers or low strikes. These products are suitable for investors with a moderate to increased risk appetite and the expectation of the underlying moving sideways over the lifetime of the product.
Participation Structured Products
Participation Structured Products are a category of structured investments designed to give investors direct exposure to the upside performance of the underlying asset(s). Like Yield Enhancement Products, Participation Structured Products may offer conditional capital protection, in which case protection is only granted if a predefined condition is met (i.e. a barrier has not been reached). Market expectation should be a directional move (up or down) over the lifetime of the product
Reference Entity Products
Reference Entity Products are a category of structured financial instruments whose performance and payout are directly linked to the creditworthiness of a specific reference entity (such as a corporation, sovereign government, or financial institution). These products, also known as credit-linked notes, are often based on credit derivatives such as credit default swaps (CDS).
Leveraged Structured Products
Leveraged Structured Products are financial instruments designed to amplify an investor’s exposure to the performance of an underlying asset(s). They use financial leverage – often through embedded derivatives like options, futures, or swaps – to magnify both potential gains and losses. Market expectation should be a strong up- or downwards move, and products are best used as short-term speculative investments requiring daily supervision or as a short-term hedge.
With both the top-level distinction and the sub-categorization according to the payoff profile of a product this solution combines the most important requirements of all Eusipa members.
ISSUERS
Capital-guaranteed or protected investments are structured, complex financial products and should not be confused with bank deposits. While banks and regulated deposit-taking institutions may issue these investments, they do not provide the same security or legal protections as funds held in savings or transaction accounts.
Most of the time, structured products are built under the form of debt obligations payable by the issuers. The products constitute immediate, unsecured and unsubordinated obligations of the issuers, which, particularly in case of insolvency of the issuer, rank Pari-passu with each and all other current and future unsecured and unsubordinated obligations of the issuer, except for those that have priority due to mandatory statutory provisions.
Consequently, investing in a structured product exposes the holder to the issuer’s credit risk, i.e. the possibility that the issuer may default on its payment obligations. This credit risk is independent of the market risk tied to the performance of the underlying asset(s) determining the product’s returns.
It is therefore essential to carefully check who the issuer of the product is before investing. The guarantee or protection is only as good as whoever stands behind it. Issuers with higher funding costs may present structured products with more attractive terms – such as higher yields or enhanced payoffs – compared to competitors. However, these seemingly favourable conditions may come at the expense of increased credit risk, reflecting the issuer’s or guarantor’s weaker financial position.
The issuer and its guarantor may also be subject to banking regulations that empower the resolution authorities to apply specific resolution tools to credit institutions under certain circumstances. These measures include the write-down or conversion of securities into common equity of such credit institution (the so-called bail-in). A write-down or conversion would have the effect that the Issuer would insofar be released from its obligations under the Structured Products. These resolution tools may therefore significantly impair the rights of structured product holders, including the suspension, modification, or full/partial cancellation of their claims under the structured products.
RISKS
Before deciding on a structured product, investors should familiarize themselves with the relevant risks and special features. Beyond issuer risk, structured products carry several key risks and features that require careful consideration. In general, these risks are described in the final terms of the product and in the base prospectus for the issuer’s programme. The risks below are not meant to be an exhaustive description of all the risks involved in any individual structured product, but rather a general statement of the risks commonly associated with Structured Products.
Market risk
The return on Structured Products is directly tied to fluctuations in the level, value, or price of the underlying asset(s). If the performance of the underlying asset(s) differs from the expectations at the time the structured product was created, the investor may end with no return at all, or even incur a loss of capital, potentially amounting to the entire initial investment.
Valuation risk
Most structured products are designed to be held until maturity. However, the value of the structured product at any time prior to maturity may fluctuate positively or negatively and may be substantially different than the payment expected to be received at maturity. The valuation of the structured product prior to maturity will be impacted by several market factors including the performance of the underlying asset(s), the interest rates fluctuations, the change in the expected volatility of the underlying asset(s), the change of the expected dividends and/or distribution of the underlying asset(s), the remaining time to maturity, the exchange rates, etc…
Liquidity risk
Liquidity risk denotes the possibility that the investor may not be able to dispose of a structured product at any given time or at a reasonable market price. The payout profile of a structured product defined in advance is always valid only at the end of the term. Before the end of the term, it may not be possible to sell the product at an acceptable price, for example because no binding prices are quoted for it.
An investment in a structured product does not give you any of the rights associated with the ownership of the underlying itself – such as voting rights, subscription rights, dividends or interest