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When Rabobank, the Dutch lender, sold an innovative form of bond earlier this year, the bankers involved in the deal were clear on one point. “Please don’t call it a cat bond,” they begged.
Cat, or catastrophe, bonds are designed to help cover the insurance losses from natural disasters. Like cat bonds, where bondholders’ investments are written down if a pre-agreed event such as a hurricane occurs, Rabobank’s contingent capital bonds will see the value of bondholders’ investment fall if a set capital ratio is breached.
There are two points to take from this deal. The first is bankers’ sensitivity to names and phrases, although it is understandable that few financial institutions would want the word “catastrophe” in any way linked with them.
The other, more important, point is that the structure of the deal was innovative, but its key features were not. Right now, the future of wholesale financial products looks like variations on a theme rather than any broad reimagining of the sort that characterised the credit boom ahead of the financial crisis.
“It is like playing with a toolbox, or lots of little Lego bricks, that you already have,” says one capital products structurer. “This is what financial innovation looks like. We are not redefining the world right now.”
Crisis-related themes still loom large in the world of products. Since the turmoil graphically revealed the problems with the complex products of the boom years – hard to value, opaque about their contents – policymakers have focused their attention on putting fixes in place.
A key area of work is the very basics of securitisation – the process of bundling together thousands of individual loans, such as mortgages or credit card borrowings, into new bonds backed by the repayments from those loans. The market is considered important for any sustained economic rebound because of the role it plays in extending credit by taking loans off banks’ books, freeing them up to make new loans.
The big theme is simplicity. Investors are justifiably wary of overly complex products and have pushed for simpler structures with fewer tranches in an effort to make it easier to value each slice.
Investors – notably central banks, given the trillions of asset-backed securities they hold in collateral for the liquidity they injected into the financial system – are also pushing for more information about the underlying loans to help them analyse each deal.
That all this will happen to some extent is now clear. What is not is the exact detail and, crucially, whether the rules will match up across borders.
“We don’t have any objection to the idea of transparency and putting more information in investors’ hands – we want them to have confidence. But please, give us consistent rules so people don’t trip over themselves,” Steve Gandy, head of securitisation at Santander, the Spanish bank, and chairman of the European Securitisation Forum, said last month in response to a consultation from the US Securities and Exchange Commission over new rules for the industry.
This uncertainty is a drag on the market, bankers say, because it is hard to get clarity on what new forms of securitisation will succeed. “An extreme exercise of patience is required until such time as the market finds its ‘new normal’,” says Jim Irvine, head of structured products and advisory at Henderson Global Investors, the fund management group.
The same goes for hybrid bank capital products, another market where the crisis exposed flaws but that is also viewed as integral to the recovery because of its role in shoring up banks’ balance sheets.
Hybrids, which contain features of both debt and equity, sit below senior debt and can be counted towards a bank’s regulatory capital. They caused controversy during the financial crisis because of many banks’ reluctance to upset important investors by exercising the equity features that would have allowed them to hold on to the cash, bolstering their capital.
The Basel Committee on Banking Supervision has made it clear these products will have to change significantly if they are to be counted as capital, but has yet to make its exact feelings clear.
This has left the market in virtual limbo, and Rabobank’s deal the exception that proves the rule. For now, the future of financial products is still largely in the hands of the regulators.