Investment loses health certificate

Mit freundlicher Genehmigung von Gruner + Jahr

By James Wilson in Frankfurt

Published: December 8 2008

Promoters of one of Germany’s most popular retail investment products are fighting to salvage a reputation battered by financial turmoil and customers’ losses after the bankruptcy of Lehman Brothers.

The market for the structured investment products known as Zertifikate, or certificates, had grown rapidly over the past five years as German investors have lost faith in equities.

These derivatives, with comforting names such as discount, guarantee and sprint certificates, allowed investors to gain exposure to equities or other asset classes in products that offered extras such as more leverage or guaranteed bonuses if markets remained steady.

However, money has been pulled out of Zertifikate as equity markets have plunged. A further blow was dealt by Lehman’s demise. Investors who bought certificates issued by Lehman face a battle to recoup their investments, which are not covered by bank guarantee schemes.

The anger of those investors is particularly acute because many bought the products from third parties such as local saving banks. Lawyers acting for investors believe many were badly advised by sales staff and might not have realised the true risk of the products or even the ultimate issuer.

Klaus Nieding, a lawyer and representative of the DSW, an association representing investors’ interests, is following some of the cases and says 90 per cent of them involve pensioners. “The oldest is 96 years old,” he says, and adds that such investors should never have been advised to purchase the certificates.

Last month, a judge dismissed a claim against the Frankfurter Sparkasse, one of the banks that sold Lehman products, from a couple who claimed they had been badly advised.

Germany is the biggest market for such products, which are issued by big retail and investment banks. About 370,000 different certificates are outstanding but most volume is in about 40,000 more popular products. The value invested reached almost €140bn ($181bn) a year ago but had dropped to €110bn in September and is likely to have shrunk further.

Aside from the problems linked to Lehman – which had a small share of the certificate market – investor enthusiasm has waned because some products have failed to deliver expected results. “Bonus” certificates, which promise an extra return if the underlying share or index remains above a determined level, have been hard hit by market falls and many have failed to pay out.
“There has been a deep crisis of confidence,” says Eckhard Hülsmann, head of structured product sales for Europe at DWS, Germany’s biggest fund manager. Tax changes due in January are also affecting interest in some types of certificate although some will benefit.

Restoring confidence is important, says Hartmut Knüppel, of the German Derivatives Association, the DDV. It has joined with the DSW to publish a checklist of questions to guide potential buyers. In an attempt to increase transparency, the European Derivatives Group, another industry body, has begun to publish indices that measure the performance of popular types of certificate against the EuroStoxx 50.

The DSW is also calling for more transparent fee structures for certificates. Opacity of pricing is a long-standing complaint of critics who think investors would often do better to buy the share or other instrument on which a certificate is based rather than the derivative.

Thomas Timmermann, head of equity derivatives at Commerzbank’s corporate and markets division, rejects criticism of high costs or intransparency. “There is fierce competition and margins are tiny. There are websites that make the costs easy to find out . . . There is a lot of noise in this market because we are diverting money from traditional asset classes.”
In further attempts at reassuring investors by avoiding another Lehman-type failure, DWS and Commerzbank have introduced “safe” certificates where assets to repay investors are ringfenced in case of issuer insolvency.
Mr Timmermann says: “This is a booming industry . . . We are confident that the success will continue.”

Mr Hülsmann says certificates will continue to offer advantages over mutual funds, such as focused exposure to particular asset classes. But he says the industry must learn.

“In the future, you will have much more transparency. You need to see exactly what the risks are,” he says. “Many of the products were much too complicated . . . a lot of the products that you cannot explain to a retail client in three minutes will disappear and we will be back to the structures that made the industry successful.”