Monday, February 11, 2013

Structured Certificates of Deposit Week


Over the past several months, we have noticed more and more bank deposits that resemble structured products.  These products go by various names: market-linked certificates of deposit, equity-linked certificates of deposit, contingent interest certificates of deposits, etc.  For parsimony, we refer to these types of products as "structured CDs" or simply "SCDs".

We think structured CDs are a very significant development, as they can be designed to provide highly complex exposure, are almost entirely illiquid, and are sold in a non-transparent marketplace.  We have discussed structured CDs briefly in the past, but we think that the structured CD market is so interesting, and coverage of the subject in the financial media is so sparse, that we are devoting this week to explaining what these products are, how they work, and why we think they are worth paying attention to.

Structured CDs are basically bank deposits that resemble principal protected structured products.  Like traditional CDs, they promise return of principal at maturity along with interest payments, except that the interest component of a structured CD depends on the value of reference assets such as stocks, ETFs, interest rates, or indexes.  This derivative component can be made extremely complex, or the SCD could be linked to an asset that itself has complex exposure.

On major selling point for structured CDs is that they are eligible for FDIC insurance since technically they are a type of bank deposit.  While structured products, which are technically debt, expose investors to the credit risk of the issuer, some portion of a structured CD is backed by the full faith and credit of the US government should the bank go under.  We'll go into the details of FDIC insurance in a post later in the week.

Structured CDs are also almost entirely illiquid.  Like traditional CDs, redemption before maturity typically incurs a penalty or fee, and interest is typically non-transferable.  Because of the limits of FDIC insurance, structured CDs are typically sold in small units, suggesting they are marketed primarily to retail investors.  Despite the clear resemblances to derivatives and other complex securities, structured CDs fall outside of the purview of the SEC and its disclosure requirements.  As a result, the full extent of the structured CDs market is difficult to ascertain (though it has been estimated at approximately $25 billion annually), as are the sales practices through which they are sold to investors.

We hope you stay tuned and contribute to the discussion, either through the comments section or by emailing us any questions or suggestions you may have.  Welcome to structured CDs week at the SLCG Blog!

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