Frankfurt

The German structured products market is growing steadily again and providers are involved in an intense battle for market share.

The financial crisis led to a big drop in issuance of structured products in Germany, and total outstanding products have yet to get back to pre-crisis levels. But new business activity is strong and Germany remains the biggest structured products market in Europe, with total outstandings of more than €110bn.

In the wake of the collapse of Lehman Brothers in late 2008, distributors went into safety-first mode and cut back their provider lists, but third-party distributors such as private banks are now expanding the number of providers to offer a wider range of products to their clients. As the market opens up again and as retail investors come back in, there is an opportunity to grab market share with the aim of keeping it over the long term.

The dominant players remain the commercial banks with big branch networks, notably Deutsche Bank, Commerzbank and HypoVereinsbank (HVB). Added to these are co-operative bank DZ Bank and landesbank WestLB, which also feed into big affiliated branch networks. They have formidable distribution power in the mass retail segment. For example, Commerzbank has 1500 branches across Germany, a number boosted by the 2008 takeover of Dresdner Bank. But the big banks generally have open architecture, which gives access for outside providers looking to sell their products via these distribution networks.

New entrants

Foreign banks are being quite aggressive at present. RBS acquired the well-known ABN Amro brand in the German structured products market in 2007, and has continued to build up a strong mass retail presence under the RBS name. Barclays Capital is also an active provider of products for third-party distribution, mainly to high-net-worth-individual accounts via private banks, and HSBC is a major player via its ownership of private bank Trinkaus & Burkhardt.

Swiss bank Vontobel is in the middle of a strategic push to boost its German presence, and the Oppenheim name has returned to the structured products space. After the Sal Oppenheim private bank became overstretched during the financial crisis, it was acquired by Deutsche Bank. However, Deutsche did not need the investment banking units and sold the equity trading and derivatives, and the capital markets sales units to Macquarie.

During the re-organisation and sale process in the first half of 2010, Sal Oppenheim scaled back new structured products issuance, but following the Macquarie acquisition it has been very active since last August. It has been ramping up activity with new products in Germany, Austria, Switzerland and Italy, and a substantial marketing campaign to establish the new Macquarie Oppenheim brand.

Risk appetite rising

Rupertus Rothenhauser, head of sales and public distribution at Macquarie Oppenheim in Frankfurt, says investors have this year begun shifting out of classic bond-like products such as floored floaters (index-linked notes with a minimum return level) and step-up bonds (which offer a higher rate of return if a particular trigger is met) into more equity-linked products.

“At the end of last year many investors reviewed their portfolios and saw that they had made relatively low returns buying cash bonds, while global equity markets had risen strongly," says Mr Rothenhauser. “They are now willing to take a bit more risk in order to increase returns, but still want classic transparent products, such as bonus certificates and auto-callable issues.”

He adds that for the first time in three years there is a lot of interest in thematic baskets such as emerging markets equities, although the recent crisis in the Middle East and north Africa has shown investors they have to understand political risk in emerging markets.

One product being offered by Macquarie Oppenheim is a bonus certificate that pays a high coupon conditional on the performance of equities in six emerging market countries, including China, Vietnam and Malaysia. This product is structured using exchange-traded funds, which are increasingly being used by product providers as basic building blocks because they are a highly liquid way to gain exposure to a variety of markets.

Vontobel's progress

Vontobel is also strengthening its presence in Germany and, as part of this process, last September appointed Wolfgang Gerhardt as head of financial products, Germany, leading the Frankfurt-based team at Bank Vontobel Europe.

Third-party distributors and retail investors are more aware of counterparty risk since the financial crisis and, for example, often look at credit default swap (CDS) levels for an issuer. Given its strong balance sheet, Vontobel does not issue bonds and has no CDSs but enjoys a good reputation in Germany. Distributors feel comfortable adding its products to their lists.

"We made significant progress in 2010 and having almost arrived as one of the top 10 institutions in the German structured products market, we plan to establish ourselves as a major long-term player in both investment products and leveraged products," says Mr Gerhardt.

"The key issue is to understand how retail investors think and adapt to the differences between the Swiss and German markets," he says. "In Germany there is less of a difference between types of products bought by high-net-worth-individual clients advised by private banks and self-directed investors who can be reached directly via print advertising or investor roadshows.”

He notes that both groups currently focus on products such as reverse convertibles, bonus certificates and discount certificates. Vontobel has also adapted its Deritrade structured products internet platform for the German market so that private wealth managers and advisors at private banks can tailor products to their clients’ exact specifications.

Safe exposure

Given the various crises on equity markets in recent years, many investors are looking at safer ways to get exposure to equities without simply taking a long position by buying shares. The Deutsche Derivate Verband, an organisation that represents the 18 leading providers of structured products in Germany, has been highlighting this trend as part of its effort to bring more investors into structured products.

Major structured products providers and distributors, such as Deutsche Bank and Commerzbank, have had a lot of success over the past six months in marketing products such as express certificates, which may mature early if a pay-off target is reached, and reverse convertibles, which generate a high coupon as long as an underlying stock makes a small gain.

Express certificates typically have a longer-term maturity of four or five years. Deutsche Bank, whose structured products are sold via its X-markets division, markets its express certificates as being mainly suitable for conservative investors willing to forego unlimited upwards participation in favour of a security buffer, and a chance of attractive returns during slightly rising, stagnating or even slightly falling prices for the underlying asset. Reverse convertibles have a shorter life and Commerzbank has been seeing rising demand for reverse convertible-type products over the past six months.

"One year ago investors were reducing their structured products portfolios but they are now looking for new investment ideas," says Anouch Wilhelms, product manager at Commerzbank Corporates & Markets in Frankfurt.

"Reverse convertible products with a high coupon are very popular at the moment, especially given the very low interest rates on offer in savings accounts," he says. "They are typically six- or 12-month products because investors have a strong opinion for that time period, after which they can choose a new product and reinvest their money."

Some reverse convertibles have a defensive mechanism and there is a safety buffer protecting capital unless the underlying share has a big drop, for instance, by more than 30%. German blue-chips companies, such as Allianz, Bayer, BASF or Daimler, are among the most popular underlyings.

"One advantage is that big German blue-chip companies are global players so, for example, with Bayer or BASF, investors are also getting exposure to emerging markets growth," says Mr Wilhelms.

Home comforts

Bankers say German blue-chips have always dominated the market and German investors initially pulled back even more into their home market as a safety measure after the Lehman Brothers' collapse. As confidence began to return they realised the German economy was surging ahead as the motor of the EU recovery, on the back of a rapid rise in exports. German equity underlyings remain in vogue as a result.

In February, HVB, which is part of the UniCredit group, announced it was now offering structured investment products under its new, pan-European brand called 'onemarkets'. Underlyings cover the entire range of asset classes: equities, commodities, interest rates, currencies, ratings, funds, hybrids and alternative investments. The onemarkets platform is seeing more risk appetite in 2011, in contrast with last year when German investors were in safety-first mode.

"Reverse convertible products have helped bring German retail investors back into the stock market following the financial crisis," says Dominik Auricht, specialist in structured investment products at HVB onemarkets in Munich. "As in other countries, German investors tend to buy mainly into their own home market and the most popular single stock underlyings are major DAX components, such as Deutsche Bank, Allianz or Siemens.

"High-net-worth individuals tend to have bigger portfolios which are skewed more towards stocks, but although there is a bit more risk appetite to be seen this year in the mass market space, mass retail is still dominated by capital-protected products or coupon structures with very low barriers, where investors will only lose part of their capital if there is a big drop in equities." 

Return of demand

RBS has also benefited from the return of demand for structured products with equity underlyings in the German market. "The use of structured products has been instrumental in bringing investors back into equities," says Andrea Sozzi-Sabatini, head of sales, equities and structured retail at RBS global banking and markets in London.

"The German market was dominated by fixed-income products in 2010 but since the beginning of the year we have seen more interest in equity underlyings, including getting access to emerging markets for private banking clients," he says.

HSBC is also a major player in Germany, via a long-established private bank Trinkaus & Burkhardt, which late last year celebrated 225 years in business. “There is always a high correlation between rising equity markets and an appetite for more risk in structured products," says Heiko Weyand, director of marketing, retail products at HSBC Trinkaus & Burkhardt in Düsseldorf.

“There is currently good sentiment in the market and we are seeing heavy demand for short-term products, such as reverse convertibles on single underlying stocks, such as Deutsche Bank and Nokia, as well as indices, such as the Euro Stoxx 50 and the DAX. Investors like the chance of quickly making a 6% or 7% absolute return and then investing in something new as soon as their money is returned."

What’s in a name?

The German distribution network is quite open to third parties, with most distributors offering a wide range of products. For example, RBS or Barclays Capital has access not only to private banks but also to the big universal bank distribution networks.

Issuer risk is not the overriding theme that it was after the collapse of Lehman Brothers, whose notes were widely distributed in Germany. In fact, many self-directed investors are now actively willing to take issuer risk and buy products that are attractively priced because of the higher funding cost levels of the issuer.

As in other European markets, German regulators have introduced stricter reporting requirements so that investors can compare products more easily. For capital-protected notes, the issuer often uses its own credit risk to structure a zero coupon bond, which will guarantee full return of principal upon maturity.

But a lower-rated institution paying higher spreads on its debt is clearly able to structure a better pay-off than a highly rated institution with tighter spreads. Most investors were not aware of this in the run-up to the financial crisis and Lehman Brothers was an example of a bank doing funded trades with generous pay-offs that attracted many investors.

The new disclosure requirements make it much simpler to model returns and pay-offs, so third-party distributors are required to inform end-investors if two similar products have different pay-offs because one carries a higher issuer credit risk than the other.

Distributors keep track of trends in CDS spreads to see if problems may be looming for providers. They are also aware of the basic balance sheet data of a provider, such as overall leverage or Basel capital ratios. Tracking this type of information was less common before the financial crisis. However, while information such as CDS spreads is now to be seen in retail finance magazines, issuers say end-investors tend not to follow this too closely but like good name recognition instead.

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