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A press release from the Financial Services Authority with the heading Lehman Structured products — Update is hardly calculated to set the pulse racing, but behind it lies one of the biggest scandals of recent times and one that may well cost the asset management industry a fortune in compensation.
Most people will not know what a structured product is, but they probably have one all the same. A fixed-rate mortgage is a structured product. A bank or building society account that offers half the gain on the FTSE index over five years or your money back at the end of the period is too. So are all those insurance bonds that offer minimum guaranteed returns on one hand, and a link to gold, oil, property or any other asset class on the upside.
In fact, any modern savings or investment scheme that contains some kind of guarantee is likely to come into the category and to have — and this is the nub of it — some kind of financial derivative at its heart on which the whole scheme turns.
The derivative provides the insurance against shares, gold or whatever going down instead of up. It's a huge business. In the UK, the total value of retail structured products is estimated at £38 billion.
Now for the juicy bit. Among the hottest-selling investment products in the run-up to the crash were schemes that promised returns linked to share prices on the upside and all or sometimes just 90% of the investors' money back if the markets failed to perform.
Given that the main reason to avoid equities is the risk that they will fall and lose you money, a product which removed that risk was bound to be a good seller. The big banks and stockbrokers, particularly in mainland Europe, sold them by the bucketload. Across Europe, the sums invested could be measured in the billions, their commissions and charges in the tens of millions.
Now the customers who went to their high street banks, and were sold a product by the staff of those banks, and which probably had the bank's name on the cover, might reasonably have thought they knew who they were dealing with. However, what they may or may not have known, and what they may or may not have been told, was that the product contained a derivative. Every derivative has to have a counterparty which will pay out if markets go the wrong way, and in this case the counterparty was Lehman Brothers.
By now you should know what happens next. When Lehman Brothers went bust, all those guarantees went bust too. So the careful, prudent investors who thought they were insured against the crashing stock markets found that they weren't. Their guarantees were worthless. They had lost at least as much as the markets had fallen and probably, after costs and fees, considerably more.
The fund management industry does not like to talk about this but clients are suing the pants off the people who sold these things — the advisers and intermediaries — usually on the grounds of non-disclosure. Their success or failure will depend on whether or not the intermediaries can produce client agreements that say in tiny print at the bottom of page 95 that Lehman was a counterparty, and whether the judges will think this counts as sufficient disclosure. M'learned friends will do very well out of this, even if no one else does.
All of which is by way of background to the press release mentioned in the opening paragraph, the first line of which said: “NDF Administration Limited (NDFA) and Defined Returns Limited (DRL) have today announced that they are going into administration.”
Guess what? These two firms were among the many who marketed structured products in the UK to retail investors. There were concerns that their marketing literature did not adequately explain the risks. So they have gone into administration so there is nothing left to sue. Clients will have to take their chances with the Investor Compensation fund.
Meanwhile, as the financial services sector never tires of telling us, its number one priority is to rebuild public trust in the industry.
UKFI has reason to feel defensive
Most of the financial stuff that was taken over by the Government is parked in UKFI, a body set up a year ago in order to manage the investments.
That organisation yesterday published its investment mandate with a long explanation of how UKFI would “follow best institutional shareholder practice... including compliance with the Institutional Shareholders Committee Statement of Principles together with any developments to best institutional shareholder practice arising from recommendations or guidance contained in the Walker Review or elsewhere”. Phew!
Why does it feel the need so comprehensively to cover its back?
Perhaps because Lord Myners wrote an article in the Financial Times the other day under the heading: “We need more responsible corporate ownership”. In it, he noted with regret that “ownership has become divorced from control”.
KBC Peel Hunt's Jonathan Allum, picked up on this saying that as owners the Government should find it easy to tell the banks to comply with its wishes in terms of lending and bonuses. But it chose not to, he said, and instead had “deliberately tied its hands by parking its bank holdings in a specially set up quango, UKFI”.
