Sunday, October 9, 2011

Opaque structured finance products allow Wall Street to 'swizz' market participants according to George Osborne's private secretary

As defined in the Oxford Dictionary, a swizz is something that represents a mild swindle.

The Telegraph carried a must read article on a structured product being offered by Barclays to its retail clients.

Since before the financial crisis began on August 9, 2007, your humble blogger has been advocating for disclosure.  One area I have focused on is disclosure of all the useful, relevant information in an appropriate, timely manner so that market participants could value structured finance products.

The reason it is important that market participants can value a security is that it is only with the ability to value a security that the market participant knows if the price that Wall Street is offering for the security is too high, what it should be, or a bargain.

Without the ability to value a security, Wall Street is in a position to take advantage of market participants through their marketing (think brokers...).  This situation is what the UK's George Osborne's aide would call a "swizz" and wonders why financial regulators would allow it to occur.

Please note that the same thing occurs with structured finance products sold to sophisticated investors. Examples of this include CDOs, subprime mortgage backed securities and interest rate swaps (think Jefferson County Alabama).

In short, the idea of a swizz applies to every opaque product created by Wall Street.

The only way to end this swizz is for global policymakers and financial regulators to adopt and fully implement the FDR Framework.  Under this framework, no financial product can be sold where all the useful, relevant information is not available in an appropriate, timely manner so that market participants can independently assess the risk of and value the product.
Greg Hands, personal private secretary to George Osborne and a junior member of the Treasury, said he had been offered the structured bond from Barclays as he was a customer of their stockbroking division. He said the complicated nature of the product revealed that banks still had a long way to go to make their offers transparent and suitable for investors. 
High levels of household debt and investments in unsuitable and complicated products was seen as one of the reasons for the financial crisis. 
Mr Hands, who worked in derivatives for eight years before becoming an MP, said the bond was almost impossible to price. "I do sometimes wonder about some of our banks and others with the marketing of their financial products," he said at a fringe meeting at the Conservative Party conference last week. 
No need to wonder Mr. Hands.  Yves Smith would tell you that the reason this product is being marketed is because no one on Wall Street is highly compensated for developing low margin, transparent products.
"I am a client of Barclays stockbrokers and I am amazed at some of the stuff they are putting out to purely retail individual investors, not high net worth clients." 
At the event organised by the Social Market Foundation Mr Hands then referred to the recent offer he had received from Barclays: "This is an exclusive offer until the 28 September," he said the offer document explained, before continuing: "It is a very complicated product that is a bond linked to the level of the FTSE. 
I used to price some of these products and it was not possible to price this product. I'm not saying Barclays is exceptional in this, I believe other banks are likely to be similar. But there are a very complicated set of options embedded in this product which are called in the world of derivatives an American style set of binary options where basically your capital is at risk if at any point during the next five or six years the FTSE falls below a certain level. 
"You could end up losing a considerable part of your capital which I don't think is particularly explicit in this product." 
There is no reason to believe that high net worth or sophisticated investors would be able to do a better job of pricing this product than an individual with experience like Mr. Hands.  The same lack of transparency into the true risk of the product would also be a barrier to their investment advisors in evaluating the product.
Mr Hands said that only at the bottom was there a suggestion that "structured products are not for everyone" or investors should "seek independent advice". He said many retail investors did not have access to suitable advice. "This is basically what you would call on the street a swizz....
Last night, a spokesman for Barclays said: "Barclays Stockbrokers provides a service through which clients can trade a wide range of securities. We make available from time to time structured products which enable sophisticated investors to express a view on the market. The literature complies with FSA guidelines and makes it clear investors' capital is at risk."
The problem currently is and has been since well before the beginning of the financial crisis that disclosure is inadequate.

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