Creditflux Newsletter

Plenty of people believe that it was the unbridled inventiveness of credit structurers that got us into this mess. The last thing they want to see is a return to the days of synthetic super senior swaps on CDOs-squared, CPDOs and structured investment vehicles.

But product innovation does not have to mean the kind of ratings and regulatory arbitrage that created those products. It should be about coming up with imaginative, commercial solutions to problems. Yet it seems that credit market practitioners are now so cowed by the public backlash against their previous efforts that they have lost the ability to think creatively.

Take, for example, that staid but safe financial investment known as the high yield bank loan. Diversified portfolios of loans have proved their resilience to deep recession. And there are big groups of investors, such as pension funds and family offices, which are now familiar with the benefits of investing in loans, but are put off by the low returns. There are also large numbers of institutions, such as banks and insurance companies, that have cheap sources of funding and need somewhere safe to put the money. Bring these three elements together, with the first group providing the capital and the second group the leverage, and you should have a business that catches fire.

But, instead of coming up with a neat new way to bring these investors together, investment banks are peddling the exact same loan investment product they were selling in 2007: the cashflow CLO. They haven’t even had the sense to call it something new. CLOs make real sense for many investors, but there are few investment committees in the world who will sign off an investment in a three-letter acronym. It’s no wonder that CLO arrangers have had little success recently.

Of course, product innovation should not simply be about rebranding. It should be about designing products that people want, and that can turn customers into loyal repeat customers.

Financial markets have always made a poor job of this. There are no iPads or Ferraris in finance. The closest thing to a well designed, popular product may be the iShares ETF. (And that is a retail product: the wholesale markets have produced nothing comparable.)

It may be that product development skills are not prized in this industry. While other businesses have large numbers of people who design products, almost everyone who works in finance is either a trader or a sales person. To the extent that these people think about product design it is always with an eye to getting the next transaction done, rather than creating something lucrative for the long term.

But this cultural aversion to product design is probably a symptom rather than a cause of the problem. The main reason that so few bankers are designers is that finance is driven by regulation. Instead of creating products that customers want, bankers create what they think they can get past regulators (or surrogate regulators such as the rating agencies).

And the current lack of innovative thinking in financial markets is undoubtedly the result of the lack of clarity about future regulations. But it doesn’t have to be this way. Other highly regulated industries, such as pharmaceuticals, manage to innovate.

We now have a clear idea about the broad thrust of future financial regulation (more capital, more focus on liquidity risk, better disclosure), even if we don’t yet know the details. So it should be possible to come up with innovative products that will stand the test of time.