The "evolution" of investment products. Is it a need of our times?
Despite the fact that there are ongoing debates about the reasons which led to the financial crisis, it is clear that during the time when the crisis emerged, some of the largest financial institutions in the world (Citigroup, Merrill Lynch, UBS, AIG etc.),while having assumed enormous risks related to the mortgage loans and other risky investments, failed to increase their capital adequacy and to create instruments of absorbing potential damages. The internal procedures of risk management as well as the preventive supervisory arrangements failed precisely because they did not properly assessed the risks.
In other words, it was made clear that the share capital had been inadequate for protecting the financial institutions especially in times of financial instability when the investors are not willing to place further funds. In this context, new complex investment products were formed in order to be able to "absorb" in the future the possible damages of the financial institutions. Perpetual bonds, derived products and recently the CoCoCos (contingent convertible bonds) were doubled. The key difference between these bonds (contingent convertible bonds) and ordinary bonds lies in the fact that their conversion in shares does not depend on the discretion of the bond holder, but this happens automatically (automatic conversion) in case an event emerges relative to the financial condition of the issuer (trigger event), or its conversion depends not on the bond holder but on the issuer (convertible at the option of the issuer). It is evident that, the risk into share conversion is affected: a) by the financial and corporate model every bank adopts, b) by the variability in its profits and losses, c) by the quality of its capital base (which is decisive for its capital adequacy). For a graphic way of CoCoCos function click here http://lexicon.ft.com/term?term=cocos
The problem concerning these new and extremely complex investment products does not lie in their issuance itself, but, mainly, to the aggressive way in which they became promoted. Investment strategies that in the past were available only to professional investors started being offered to individual clients –even to retail clients sometimes – as equivalent to capital guarantee. Certainly, we are able to draw that conclusion now, in 2014, when we can all see the results of this "aggressive" strategy of the financial institutions, banks and investment firms. Now, we are able to discern that eliminating the distinction between investment and commercial banks was disastrous. Before that, we were simply recipients of ads using enticing slogans such as ‘absolute return’, ‘capital guarantee’ etc. and gathered that everyone is treating us bona fide and is acting considering our interest, without, however, us being able to comprehend how these investment products work.
With the knowledge we have today and the insecurity we feel due to the banks, the bankers and the financial institutions, the least we can do is always seek for the proper information.