Structured products, what are they and how do they work?
A structured product is a combination of two or more financial instruments that comprise a single structure. It is a single and indivisible package consisting in the combination of an interest rate-linked product plus one or more financial derivatives.
The financial derivative is referenced to one or more assets, the so-called underlying asset/s, with a preset maturity term. There are many underlying assets: Shares, exchange rates, interest rates, stock indexes, indexes created by other companies such as BBVA's Quantitative Investment Strategies… the trend of the underlying asset will determine the profitability of the structured product, together with the return of the principal invested at maturity.
The incorporation of the financial derivative to the structured product as an integrating part thereof, allows benefitting from a fixed or variable profitability assuming a specific risk over the life of the product and/or at maturity, i.e. at the time the maturity period expires.
Based on the level of risk at maturity, we will make a first division:
- Structured capital-guaranteed products: Those that guarantee the return the original amount invested at maturity. This category includes Structured Deposits. They are regulated by the Bank of Spain and covered by the Deposit Guarantee Fund.
- Structured capital-at-risk products: Those that do not guarantee capital repayment at maturity and whose return will depend on the trend of the underlying asset(s).This category includes Financial Contracts. They are regulated by the Spanish National Securities Market Commission (CNMV).
Depending on the format used when issuing a structured product we will talk about:
- Structured deposits: with capital guarantee at maturity
- Funds: with or without capital guarantee at maturity
- Structured note or bond: with or without capital guarantee at maturity
- Financial contract: with capital risk at maturity
The instrument used at the time of the issue will determine the inherent nature and risks, tax regime, liquidity of the product, and the type of customer that it targets.
Thus, structured products offer a great variety, not only depending on their nature, but on the assets in which it invests, providing exposer to different markets or underlying products depending on the risk profile the investor is ready to assume.
However, investors must bear in mind that these products are complex, and their inherent risks can be hard to fully understand for the customer. Another particularity of these products is that their liquidity is limited because they cannot be traded in secondary markets. It is also important to ensure that the time frame of the investor coincides with the maturity term of the product, although many issuing institutions such as BBVA accept early cancelations at market prices.
In the current interest rate scenario, structured products are consolidating as one of the most appealing alternatives for customers, who try to optimize and diversify the profitability of their savings. The flexibility at the time of producing them allows adjusting their characteristics (risk, maturity, underlying assets, profitability...) to the customer's investor profile.
Also, as a result of the prevailing low interest rates, the possibility to structure guaranteed deposits is becoming more complex, and therefore, markets will likely start offering more and more products with some risks to satisfy the demands of customers looking to keep profit ratios.