Outlook 2022: Structured products sales to rise after record volume aided by fintech, volatility

By Emma Trincal

New York, Dec. 31 – Market participants are confident structured products issuance volume in the coming year will continue to be strong. Whether it will break another record as it did two years in a row is more questionable.

Since the start of the Covid-19 pandemic, sales of U.S. structured notes have exploded. The year 2021 just reached a new milestone with an estimated $90 billion, a 30% growth from $72.7 billion posted in 2020, the previous record-year, according to data compiled by Prospect News.

Sales amounted to $86 billion through Dec. 15. Figures at press time are only preliminary and will be adjusted upward to reflect wirehouse sales at the end of the month and delays between pricing and filing dates. As a result, one can expect an addition of at least $5 billion for the final days of 2021.

A continued accommodative market marrying low interest rates with rising stock prices, as well as the progress of technology, which has moved structured notes into the mainstream, have been the two main contributing factors behind the record-breaking year.

“Deals were called because the equity market rallied. Money was reinvested for lack of attractive alternatives in bonds,” said a sellsider.

Bullish calls

“I expect issuance volume to increase at the same pace this year or even more,” said Matt Rosenberg, director at Halo Investing.

“Most of the growth we’ve seen this past year can be attributed to technology.

“We’ve seen a tremendous amount of new buyers year over year. This will remain the pattern this year.”

At the root of some of this optimism is the realization that structured notes continue to meet two of the most important investors’ needs: protection and yield.

“The demand for structured products will increase in 2022 both for equity and rates,” predicted Joe Castelluccio, senior vice-president structured products, CDs at Cabrera Capital Markets.

“A lot of accounts will become defensive on their core holdings. The need to use structured notes as an alternative, especially to hedge long positions and get decent income, will continue to be a major trend.”

Resilient distribution

Mounting uncertainty however makes the outlook for 2022 slightly challenging. The inflationary threat, the Federal Reserve’s hawkish shift as a response to it, concerns around new Covid-19 outbreaks, which trigger bouts of volatility without mentioning the midterm elections are among the market-movers complicating the forecast.

But one industry trend may offset some of those wildcards: fintech can be counted on to support the resilience and expansion of the industry, sources said unanimously.

“Technology platforms like Simon have played a role, alongside other important factors to this year’s issuance volume growth,” said Jillian Altamura, head of growth business development at Simon Markets.

“Certainly, technology has facilitated the centralization of workflows, not just the streamlining, allowing for the sales process to be much smoother and more efficient.”

One of the benefits of these multi-issuer platforms is customization. The technology has allowed advisers to answer more clients’ requests and to quickly identify the structures that meet their needs, said Rosenberg.

“You don’t need the direct relationship with the banks anymore. The entire process is much more direct,” he said.

Technology has modified the sales cycle as well.

“My estimate of what the volume of best effort and calendar notes offerings used to be at some point as a percentage of the market is about 60% to 70%. Now the majority of total notional comes from reverse inquiries, customized deals,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

The direct effect of customization has been the lowering of barriers of entry for advisers, leading to a surging number of deals concomitant to their shrinking sizes. Over the past decade, the deal count has jumped 134% from 9,872 in 2011 to a preliminary figure of 23,074 through mid-December, according to Prospect News.

Meanwhile, the average size of deals dropped to $3.7 million in 2021 from nearly $6 million 10 years ago.

Fintech growth

The past year has seen a rapid expansion of the trading platforms.

Simon Markets, which spun out of Goldman Sachs Group Inc. in 2018, counts among its investors Barclays, Credit Suisse, Goldman Sachs, HSBC, JPMorgan, Prudential and Wells Fargo.

The WestCap Group joined to lead a series B strategic growth financing round of $100 million last summer.

In the fall, Simon Markets formed several partnerships, including one with Fidelity. The fintech platform also formed alliances with alternative investment digital firms such as + Subscribe and Envestnet.

Those partnerships are designed to maximize Simon’s efforts to provide education and access to advisers, said Altamura.

“Education is the centerpiece of our mission. Our goal is to deliver the asset class, but fundamentally combined with education,” she said.

Halo Investing has expanded into other structured investments such as buffered ETFs. In October, the company raised over $100 million in series C funding. Led by Owl Capital, the fundraising included the Mubadala-backed $1 billion fund managed by Abu Dhabi Catalyst Partners, in addition to existing investors Allianz Life Ventures and William Blair.

Luma Financial Technologies, which began over 10 years ago, has opened offices in Latin America and Europe. Some of its existing partners include Morgan Stanley, Bank of America and UBS.

Just like Simon and Halo, Luma has added annuities to its platform.

“The technology push in the industry really started in the last two or three years. It’s now coming together,” said Beals.

Advisors have become savvier and are now more comfortable running their own deals as opposed to “looking at the calendar,” he noted.

“They can design the terms themselves, order through automated pricing and manage the investments on the platform.

“We’re following a trend that happened in Asia and in Europe. The growth we’re now seeing in the U.S. is a continuation of that.”

To roll or not to roll

New buyers have contributed to the rise in issuance volume. They have also provided a margin of safety to the industry when growth is compromised due to declining stock prices, which stop the automatic calls and the reinvestments into new issues.

The breakdown between new money and rolls from autocall investments is hard to quantify, said Beals.

He estimated that 30% to 40% of sales came from new money, based on conversations with clients.

The consensus among market participants is that growth in 2022 will continue to rely on autocall rollovers.

Equity-linked notes with a call feature accounted for nearly $54 billion through mid-December, a whopping 63% of the market, the data showed.

“The catalyst for the absence of calls and rolls would obviously be a sustained rise in volatility,” said Rosenberg.

The effect on volume would depend on the intensity and length of the sell-off.

“I don’t see growth next year if calls are not coming,” Beals said.

“You would definitely see a drop in notional. But it would be less of a drop than what we have seen historically simply because we now have a broader base of advisers that have embraced structure products.”

Different equity market scenarios – from bullish to rangebound and from slightly down to bearish – would have different impacts on notional sales.

Vol. is your friend

“For those financial advisers who have money sitting on the sidelines, those who are waiting for opportunities to get better terms, a rise in volatility, provided that it’s not a massive drawdown, would be a good time to strike deals,” said a structurer.

A volatility surge next year would benefit this market, agreed Clemens Kownatzki, finance professor at Pepperdine University.

“You want to sell volatility when it’s higher, not when it’s low,” he said.

“Most structured products are short volatility. They should thrive in this environment.”

Increased volatility could also mean more money shifting from stocks into alternative investments.

“Thanks to the Fed, money went massively into the equity market. There was no other place to go. If the market is no longer so liquidity-driven, people will reduce their exposure to the stock market and look for something else,” said Kownatzki.

“I think this could potentially translate into more growth for structured notes this coming year.”

But not all investors have the stamina to trade volatility, the structurer said. While the “buy the dip” mindset prevailed in the stock market in the past year, the opportunistic approach consisting of locking in higher yields or lower barriers during a sell-off may not be widely adopted by the average adviser.

“Tactical bets are not going to entirely offset the negative impact of money not getting rolled into new deals. But it will surely help,” said the structurer.

“It's very difficult to see which of these two forces will prevail. For sure though, a market decline will temporally put a big dent in issuance.”

Beals agreed.

“Net, net, if notes don’t get called, it would cause issuance volume to drop. But some of it would be outweighed by the progresses we’ve made in making the industry more mainstream. This market today is much more sophisticated than it was two years ago. The distribution process is more automated and more efficient.”

Withdrawal symptoms

Some market participants had a more cautious outlook.

“It’s going to be hard to replicate the phenomenal growth of 2021. I’m not saying we won’t see growth, but I doubt sales will rise at the same pace as this past year,” said the sellsider.

Other observers think the market is too “dependent” on rollovers. Their forecast was more pessimistic.

“Once we have a real, severe pullback, issuance volume will be badly put on hold. That’s because this year’s record issuance was literally fed by autocalls. It’s just old and repeat business,” said a distributor.

“When the market drops, and rolls stop rolling it will be a different situation. A 10% to 15% sell-off can substantially impact the issuance volume of autocalls.”

He did not believe that new money coming in could make such a difference.

“The autocall business is not about new money. It’s about repeat sales. All that money has been rolling. What happens when the rolling stops?

“For investors, a pullback means losses and pain.

“For issuers, it will represent a slowdown in volume.

“I wouldn’t be hiring people in structuring and sales right now. The music is going to stop.”

On hedge

An industry source was even more pessimistic.

“Going into next year, I don’t have a positive outlook,” he said.

“Those two-, three-year autocalls get called after three months. They’re constantly called away. Each time, clients get charged 1.5% that comes out of their yield. But they’re happy to roll the proceeds. The adviser is happy that they do and so is the wirehouse.

“Now if this was to suddenly stop, some issuing banks would feel the squeeze, especially those whose revenues depend a lot on trading.”

The clients/advisors’ relationships would suffer as well.

“When barriers get breached, clients get upset. Most of those autocalls are worst-of, which increases the odds of barriers getting knocked out. What if suddenly what was sold as a bond alternative is no longer a bond alternative?” he said.

A declining market would also cause trading issues for the banks.

“When the price is hovering around the barrier strike, say minus 29% or minus 31% for a 70% barrier, it becomes very tricky to hedge that risk,” he added.

“There is now a debate whether those autocall notes are not having a growing and profound effect on the stock market in general, especially if the stock has a lower liquidity than usual.

Those risks are exacerbated by the size of the existing volume issued.

“A $55 billion market may not seem like a lot. You wouldn’t think of it as a potential source of systemic risk. But all of the hedging activity behind this could be an issue. It definitely contributed to big volatility swings this year,” he said.

Fast moves

Most market participants do not share this negative outlook. They are confident that technology-based distribution and creative products will provide some level of protection against volatility.

“One of the benefits of the asset class is that structures and pricing are malleable regardless of the market we’re in,” said Simon’s Altamura.

“Structures can rotate from one type to another based on how interest rates and volatility are moving. It gives issuers a great deal of flexibility to accommodate different types of portfolios. It makes the industry more resilient, allowing for flexibility to accommodate different market environments,” she added.

Some market participants envision a market that may mimic the picture of the past year: a rallying trend in equities interrupted at times by short bouts of volatility.

“What you saw in 2021 were volatility spikes for a few days which faded sharply and quickly,” said Max Grinacoff, equity derivatives strategist at BNP Paribas. (See graph)

It’s unclear how much those volatility spikes can impact issuance volume overall, he added.

“While it’s a great time to sell volatility, the window of opportunity may be too short.

“Some will jump to use that opportunity. But not every buysider will take advantage of it,” he said.

The duration of autocalls may also be too long to allow tactical investors and issuers to fully benefit from rises in volatility that only last a few days, an industry source said.

Only institutional investors with a short volatility bias who trade optionality and futures directly may be better equipped to take advantage of short-lived upticks in volatility, he noted.

All-weather investing

Perhaps one of the missions of fintech platforms is to precisely bridge the gap between institutional and individual investors, said Beals.

“It’s not as easy to price better terms when volatility rises over a short period of time...But it has become much easier to get instant pricing than it used to be,” he said.

“The platforms deliver indication levels from the issuers in real time. Advisers get pricing as often as they want.

“When they’re ready to pull the trigger, issuers can move forward right away.”

Advisers’ education, customization, and fast execution are now key factors driving issuance volume expansion, sources concluded.

Growth may no longer be exclusively market-dependent if structured notes are to become the alternative investments they were designed to be in the first place, they noted.

© 2015 Prospect News.
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