Issuers’ Commitments Would Add More Value than Any Rating Scheme Could Ever Do

Abstract

This paper analyzes the evolution of the structured products market focusing on the tools available for private investors, on which they rely for the selection process. The selection process is extremely difficult because there is a myriad of products, because of the dynamic nature of the market and market participants’ actions, and because of the complexity of many of the products. We consider the existing types of tools, in particular the rating schemes that have been proposed by industry participants to provide guidance to the investor. We propose a set of properties that a rating scheme should show and check whether the existing schemes carry these properties. Our findings suggest that the existing rating schemes do not carry the desired properties. Furthermore, for the purpose of solving a highly indefinite selection process, an effective rating scheme may not exist. In light of this, we propose the introduction of a new quantity, the floor, that has a legal and financial meaning, on which issuers can also compete in addition to price and spread. Its acceptance and use would also yield standardization towards investors’ interests by excluding some pricing practices and severely limiting others. Even though very little research has been produced in this area, we believe this to be a topic of high importance in establishing guidelines for healthy industry development and regulation that upholds investors’ interests.