Perspectives on Structured Financial Products

 Structured financial products are investment instruments available to large companies or financial institutions with complex financing needs that cannot be satisfied through conventional financial products. Such borrowers seek structured financial products to satisfy heavy capital injection needs or deal with unique financial instruments.

Structured financial products provide investors with a return linked to the performance of an asset or product. The asset or product can cover an index, equity, fund, currency, commodity, interest rate, or property market. Structured financial products are prepackaged investments that usually include assets linked to one or more derivatives (complex financial contracts whose value is linked to an underlying asset).

Generally tied to a group of securities or an index, structured financial products are designed to meet highly customized risk-return goals. Structured finance deals work to mitigate serious risks associated with many complex assets. The level of risk and payoff can be predefined.

Structured financial products include collateralized bond obligations (complex structured finance products backed by a pool of loans), syndicated loans (loans extended by a group of lenders), credit default swaps (a type of financial derivative), hybrid securities (security that combines both equity and debt features), collateralized debt obligations (structured products issued by a special purpose financial vehicle), and collateralized mortgage obligations. The latter is a type of mortgage-backed security organized by level of risk and maturity.

Typically, traditional lenders do not offer structured financial products. Also, structured products are mostly nontransferable. Unlike a standard loan, these products cannot be shifted between different types of debt.

At the core of structured finance is securitization, the method through which structured finance operators create asset pools. Ultimately the pools form complex financial instruments that large investors and corporations use to meet special needs. Securitization works to combine financial assets and instruments such as asset-backed securities (ABS), credit-linked notes (CLNs), and collateralized debt obligations (CDOs). ABS are securities derived from a pool of underlying assets, while CLNs are forms of funded credit derivatives.

Securitization promotes liquidity and is used to develop financial products for investors. Increasingly, corporations and financial intermediaries use securitization and structured financing to expand business reach, develop new financial markets, manage risk, and design new funding options for complex emerging markets.

Securitization is also important in structured finance products to reduce the focus on credit and provide alternative, less costly funding formats. Securitization promotes the efficient use of capital and transfers risk from investors. In particular, borrowers who lack stellar credit ratings can leverage securitized and structured financial products at cheaper rates.

Mortgage-backed securities (MBS) are examples of securitization, largely because of their risk-transferring ability. Mortgages can be grouped into a single large pool that allows the issuer to subdivide the pool into pieces based on the inherent risk of each mortgage. These pieces are then sold to investors.

Structured financial products can provide tailored solutions to meet a specific strategy in nearly all market configurations. However, while structured financial products are useful tools for risk management and portfolio management, they generally are complex. To meet specific investor requirements, such levels of sophistication are necessary as individual investors have their own unique investment profiles as well as market knowledge.

The performance of a structured financial product depends on the performance of the underlying index or asset. Therefore, adverse price movements could trigger a loss of capital. Structured financial product investors may not have access to their principal investment during the term of the structured note or deposit without the risk of losing a portion of the principal. If the issuer of the structured financial product goes into a debt default, investors may lose the entire principal.