Who's Greg Smith and WTF is a "Structured Product"?

Another mysterious product warning

Yesterday came the 'news' that sales of "structured products" by investment banks to retail and small business customers have soared, in spite of FSA warnings about them. Today, in perhaps unrelated news, came Greg Smith's resignation letter from Goldman Sachs, where he was executive director and head of the firm’s US equity derivatives business in Europe, the Middle East and Africa:

"I don’t know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client’s goals? Absolutely. Every day, in fact." 

Which begs the question what a "structured product" actually is, and whether small business customers and their advisers had any idea what they were buying - or that they weren't supposed to be buying them.

The explanation of "structured products" at the official MoneyAdviceService is not terribly helpful (a general comment on the site that I've made before). We're told these products involve a 'note' and a 'derivative'. But under the bold heading "How Your Capital is Protected" it says rather ironically that:

"Even if a product offers ‘capital protection’ it can sometimes fail, causing you to lose some or all of your original money."

Oh come on, you say, the Money Advice Service?! Surely the global investment banks aren't going to be selling to 'Moms and Pops'!

But that's exactly the concern. I'm sorry, but just how sophisticated do you believe the average owner/director of an unlisted business really is when it comes to finance deals involving derivatives? One chap said his firm was sold "a £601,000 amortising, enhanced collar swap" and thought it had the same effect as a household mortgage. Yet businesses are being told to go to court against investment banks if they think they've been ripped off, rather than look to the regulator.

But does the regulator really understand these products well enough to be of any help? It seems to be speaking another language altogether. The first footnote to the FSA's industry consultation paper on the subject purports to explain structured products, but somehow I doubt the average banker would understand exactly what qualifies and what doesn't, let alone its customers:

"This publication deals with structured investment products (capital-at risk and non-capital-at-risk) and structured deposits.

We define a structured capital-at-risk product (SCARP) as in our Handbook i.e. as a product, other than a derivative, which provides an agreed level of income or growth over a specified investment period and displays the following characteristics:
(a) the customer is exposed to a range of outcomes in respect of the return of initial capital invested;
(b) the return of initial capital invested at the end of the investment period is linked by a pre-set formula to the performance of an index, a combination of indices, a 'basket' of selected stocks (typically from an index or indices), or other factor or combination of factors; and
(c) if the performance in (b) is within specified limits, repayment of initial capital invested occurs but if not, the customer could lose some or all of the initial capital invested.

A non-SCARP structured investment product is one that promises to provide a minimum return of 100% of the initial capital invested so long as the issuer(s) of the financial instrument(s) underlying the product remain(s) solvent. This repayment of initial capital is not affected by the market risk factors in (b) above.

We define a structured deposit as in our Handbook i.e. as a deposit paid on terms under which any interest or premium will be paid, or is at risk, according to a formula which involves the performance of:
(a) an index (or combination of indices) (other than money market indices);
(b) a stock (or combination of stocks); or
(c) a commodity (or combination of commodities)."

All clear then?
 
Image from HappyPlace.