Hi there! If you’ve always wondered what a structurer in investment banking does, you’re certainly not alone! The term “structurer” gives a connotation that something is being built – and in the context of investment banking, that is certainly the case.
I think the trouble is, what exactly is a structurer, or more precisely, a product structurer trying to build?
Well, they’re trying to build structured products for the investment bank.
I know, I know – that still doesn’t help a whole lot.
So what the heck is a structured product?
Financial institutions are famous for wrapping up their products in vague terminology that confuses and confounds the layman.
Hey, that was what caused the 2009 Global Financial Crisis, wasn’t it? 🙁
In this article, I want to try to help you understand:
- How product structuring fits within the financial ecosystem
- What a product structurer does in an investment bank
- What a structured product is (at a high-level, because we could go on for days and not finish)
Now, to be honest, when I was writing this article, I thought of different angles and perspectives for bringing this information to you.
I could, for example, give you a pretty exhaustive list of structured products like structured deposits, structured investments, capital protected and non-capital protected, with and without barriers and caps, etc.
But I’ll leave that for another article (it’s just too much to talk about).
I also thought of giving you some idea of what an actual structured product looks like on paper, i.e. the term sheets distributed by banks will give you some idea what a structured product is.
Otherwise – and I always have this feeling – that you don’t actually understand or appreciate what something is until you’ve really seen and felt it.
But again, it’s a topic for another article!
So for this article, we’ll just get started without further ado.
1. How Does Product Structuring Fit Within The Financial Ecosystem?
First up, let’s look at how product structuring fits within the financial services industry.
I’ve laid out a very simple framework as you can see in the figure below.
I’ll explain the diagram a little.
Product Manufacturers. Now, we first need to talk about Product Manufacturers.
Product Manufacturers are financial institutions (such as investment banks) which “create” or “manufacture” products.
In our case, they manufacture structured products.
Think of it this way – Apple creates iPhones, right?
In the same way, an investment bank like Deutsche Investment Bank or UBS Investment Bank will manufacture structured products.
Now, within the investment bank, there are “product structurers”, who, with their toolbox of financial engineering concepts and rules, develop structured products.
We’ll talk a bit more about structured products themselves a bit later.
For now, just try to understand that Product Manufacturers are generally investment banks who have product structurers who design and develop structured products.
“Product structurers who design and develop structured products.” (what a tongue twister).
Ok, but I digress. Back to the topic at hand …
Product Distributor. Next up, once the Product Manufacturer develops the products, you need to sell them to clients, don’t you?
Just like how Apple will have a sales team to sell its iPhones to distributors around the world.
For example, here in Singapore, we have local distributorships (e.g. Telecommunication shops) which carry the Apple iPhone brand and sell them to retail customers.
Now, this layer – the distributors – is what I term the “Product Distributor”.
In banking parlance, a Product Distributor could be a Private Bank.
A Private Bank may make an arrangement or enter into a partnership with an Investment Bank to say:
“Hey, I had a truck load of High-Net-Worth clients and institutional clients who want to invest in your structured products.”
The investment bank would be super interested and will sell the structured product to the Private Bank at a certain “mark up”.
To be precise (and this is not shown in the diagram above) …
The product structurers in the Investment Bank would sell the structured product to the Sales Team in the bank (with a mark up).
The sale team then sells it on to the Private Bank in the Production Distribution layer (with another mark up).
The Private Bank will then sell the structured product to the end client (with yet another mark up).
So you can see that in the value chain, the end client has to pay for quite a lot of “mark ups”.
So let’s now turn to the client layer.
Client. The client here can refer to High-Net-Worth individuals or Institutional clients.
These folks are the big money – and have a LOT of cash to invest.
But these days, it’s getting tough for the Private Banks.
I know, because in my day job, I service a lot of the Private Banks.
A lot of clients are actually asking why they need Private Banks at all.
“Why can’t I cut the middle man and do these investments myself?”
This is particularly true in Asia, where clients tend to like more control over their finances and choose to do hands-on investing – through trading platforms or trying to go through other alternative investment routes such as hedge funds.
And here’s another thing …
The rich millennials these days are very investment and technology savvy.
They have access to a lot of information and it’s really hard for Private Bankers to put up smoke screens and try to “bluff” their way through.
Ok, now that we understand a little bit more about how product structuring fits into the financial landscape, let’s look at another variant.
In the diagram below, you see that we have a “Universal Bank ABC”.
Now, the way this value chain works is exactly the same as what we described for the Investment Bank and Private Bank earlier.
The only difference here being …
Yes, that “Universal Bank ABC” bit in the diagram.
Now, a Universal Bank is one which is a super large global bank, which typically offers retail, commercial, investment and private banking services to its clients.
Some examples include: Goldman Sachs, CitiGroup, Deutsche Bank, Credit Suisse, UBS and other big name banks.
Now, the key thing to note about product structuring in Universal Banks is that they have dedicated Investment Banking divisions and Private Banking divisions.
So, in our discussion, the product structurer sits in the Investment Bank and manufactures structured products.
The manner in which the structured products are sold on to the Private Banking (in this case the Private Banking “division” in the Universal Bank) – very much remains the same as per our earlier example where Private Bank B was a distinct, separate bank from Investment Bank A.
Case Study. Now, you may think why am I qualified to talk about structured products. I’m an engineer by training and don’t have a background in finance.
So how did I learn so much about financial instruments and structures?
For me, it was a very strong desire to learn more about the banking industry.
When I was young, in my work as a Business Analyst, I was skilled in this like Business Process Re-Engineering, use cases, functional requirements, etc.
But what I REALLY want to learn was the industry domain.
So I went off to do a Masters in Financial Engineering at the National University of Singapore (NUS).
That made me a lot more qualified to talk about banking products and structures – and to be honest, it helps me till this day.
When I talk to traders or Bank Relationship Managers, they are very impressed that I understand what calls, puts, ELNs, warrants, accumulators and decummulators are, etc.
2. What A Product Structurer Does In An Investment Bank
Ok, in this section, we move on to the topic of what a Product Structurer does in an Investment Bank.
Recall that I mentioned a structured in an Investment Bank manufactures structured products.
Structured products are financial instruments which are comprised of derivatives.
Now, in financial terms, a “derivative” is a contract that derives its value from the performance of an underlying asset.
Refer to the diagram below.
This underlying “asset” could be e.g. your traditional stocks, indices (e.g. the S&P 500), FX rates and others (commodities, baskets of securities and even things like the weather).
Now, the derivatives themselves take four common forms: options (calls and puts), futures, forwards and swaps.
These derivatives are then combined like Lego bricks to form a structured product.
What the product structurer in the Investment Bank does is to simulate these derivatives in a software tool, typically showing the derivative “payoff diagram” (also known as a “profit & loss diagram”.
If he or she combines derivatives (e.g. various calls and put options), the ultimate combined payoff diagram will change, until it ultimately becomes the structured product payoff diagram that the bank wants.
Here’s an example of a payoff diagram for an Equity-Linked Note (ELN) with a S&P 500 index (SPX) underlying.
As you can see, the SPX starts at a level of 2,600 at the time when you buy the structured product.
Now, when the ELN hits the maturity date, e.g. say 3 months down the road, we look at the SPX level again.
If the SPX at maturity is less than 2,600, we get back our principal.
If the SPX at maturity is more than 2,600, we get back our principal PLUS an equity upside.
The way that product structurers in an investment bank create this kind of payoff diagram is by using special derivatives as building blocks.
And to be specific, for an ELN, it can be broken down into a zero coupon bond and a call option (but that’s the topic of another article, coz I could go on for days about that).
Now, as you can imagine, most structured products are customized and one Investment Bank may produce one special kind of structure based on e.g. the Dow Jones Industrial Average index, another may create one based on a group of technology stocks.
Structured products are mostly “Over-The-Counter” (OTC) products.
This means they aren’t listed on an exchange and you need to go to an Investment Bank to buy them.
You talk to the Sales Team in the Investment Bank and they’ll tell you how much, what the structured product is like, how it works, etc.
Which typically is what we deem a “term sheet” for a structured product.
Make sure you read that term sheet very carefully before you buy the structure!
3. What Is A Structured Product?
Ok, we’ve discussed an Equity-Linked Note earlier.
But there are a LOT more structured products out there in the market – and they will confuse and confound you.
But because I want to help you understand these products, I’ll try giving you a top-down perspective 🙂
Structured products can be classified broadly into four categories, as shown in the figure below.
Let’s talk about each of these in turn.
Now, obviously, these products are MUCH more complex than what I explain below – the idea is to just give you an overall feel of what the products are so you can learn more on your own, if you so wish.
Capital Protection Products. These products, well, protect your capital. Remember the ELN we looked at earlier? That’s an example of a capital protection product.
If the market swings downwards, you still get to keep your principal.
If the market swings upwards, you still get to keep your principal plus an equity upside.
Some folks may think, wow – great. I’ll pump ALL my money into these.
Now, stop for a moment. Hold your horses.
You must remember that the payoff here only happens at EXPIRATION. You have to hold you capital in the product until e.g. five or six years later.
Also, your original principal invested would NOT be the same value six years later. It would have depreciated due to inflation.
These factors need to be considered before you run off to buy a Capital Protection Product.
Yield Enhancement Products. Now, yield enhancement products are designed to let investors profit when the market moves sideways or within a range.
That’s an interesting proposition but you should remember one important thing.
Yield Enhancement Products are typically NOT capital protected.
So do watch out for that clause when you’re considering whether to buy one.
Moreover, the “upside” that you get with a Yield Enhancement Product is usually capped.
Participation Products. Next up, we have participation products. These products are quite similar to yield enhancement products, except that they typically do not have caps to the upside.
Now, if you are not capped in terms of upside profit, you’d definitely expect to suffer more losses if the market moves against you.
Remember the golden rule of investing: more profits means you need to take more risk.
Leverage Products. Finally, we have leverage products. Leverage products allow investors to achieve an large gain with low capital.
But this leverage cuts both ways.
Investors can lose big time if the market moves against them.
There’s a reason why this kind of product is on the upper right side of my graph above – high risk, high return.
You’d want to be very careful and know what you’re getting into before buying such structured products.
You’ll learn a TON of stuff there.
I hope the above has given you some great insights into what a product structurer in investment banking does.
We’ve looked at how investment banks manufacture structured products and sell them at a mark up to Private Banks (or other financial institutions), who then sell them onward to their own individual or institutional clients.
We also covered some points about using derivatives to construct structures and how e.g. an Equity-Linked Note might give either the principal or principal + equity upside, depending on where the underlying asset is at expiration date.
Finally, we covered the four main categories of structured products out there, and how these give various risk and return profiles.
Until next time, have fun learning about structured products!
P.S. I’m sure you realize that structured products are but one part of the banking industry.
If you wish to learn more about the banking industry in general, I encourage you to check out this article or my guide book over here. They contain a lot of information on how you can pick up banking domain knowledge, which will help you in your career as a Project Manager or Business Analyst.
I also present simple frameworks to give you a broad perspective into banks' business models, customers, distribution channels and operations. Check it out here.