A bit of history

Five takeaways: (1) zero-coupon bonds and the option (1980s) are the true founding blocks of modern structured products — MBS are better seen as an early form of structuring than as a basic building block. A zero-coupon bond, bought at a discount and redeemed at par at maturity, "secures" the capital, except if the issuer defaults: credit risk never disappears. (2) Switzerland established itself as the global hub of private wealth management: this is not the work of a single bank, but of an ecosystem of players competing to meet investors' needs. (3) The SSPA, founded in 2006, structures the market through classification and transparency. (4) Lehman 2008 is the pivotal event: it made issuer risk visible and triggered today's regulation. (5) Since then, significant volume growth, driven by better-trained market participants (a firmer command of the tool), ever more relevant innovations and easier access to solutions facilitated by the various players.

MBS and the tranching mechanism. A portfolio of mortgage loans is sliced into senior, mezzanine and equity tranches: the cash flows repay the senior tranche first (low yield, low risk) then cascade down to the equity tranche (high yield, first to absorb losses). It is this logic, poorly calibrated on US subprime, that seized up in 2008 when the whole cascade defaulted simultaneously.

The zero-coupon bond is bought at a discount (e.g. 80% of par) and redeemable at 100% at maturity. The difference represents the discounted interest. Its market value moves inversely to rates. It is the pillar of every capital-protection note: the portion not invested in the zero-coupon bond constitutes the "option budget", namely what remains to buy the option that will provide exposure to the selected performance engine (for example, the upside of the equity market). With high rates, the option budget is large; with negative rates, the structure no longer works. Indeed, in the latter case, there is no budget left to allocate to buying the option.

MiFID II / PRIIPS / FinSA are not just an administrative burden. They impose a rigour that practitioners now internalise: target market (who is this product intended for?), SRI (risk score out of 7), performance scenarios (favourable, moderate, unfavourable, stress), disclosure of retrocessions. Reading a KID means answering the key allocation questions in 3 pages, before signing. Note, however, that these rules differ from one country to another (the Swiss FinSA / FINSA regime, the European MiFID II / PRIIPS regime, etc.), and it is the client's jurisdiction that determines the applicable framework.

Reverse Convertible and misselling risk. From the late 1990s, the Reverse Convertible enjoyed great success with private clients in Europe, to the point of attracting regulators' attention. The problem is not the product, but the way it is presented: an investor who hears only "high guaranteed coupon" forgets that they are actually a seller of a put option and bear the full downside risk of the underlying. In the United States, the NASD (now FINRA) issued several alerts in the 2000s on the marketing of reverse convertibles to retail clients. In France, one of the best-known cases concerns reverse convertible-type products distributed through the network of a major French retail bank in the late 1990s: the sales pitch allegedly led savers to believe their capital was guaranteed, when in fact they bore the downside risk of the underlying. The lesson is permanent: explaining a product badly is a risk in itself, distinct from market risk.

The 1987 crash and the birth of the volatility skew. Before 1987, pricing models assumed a single volatility regardless of the option's strike. The crash revealed an asymmetry: markets fall hard and fast, but rise slowly. Investors therefore pay more to protect themselves on the downside, so that the implied volatility of low-strike options (out-of-the-money puts) becomes higher than that of high strikes (out-of-the-money calls). This asymmetry (the skew) is today at the heart of the pricing of every barrier structured product. A dedicated visual explanation will be the subject of a module on volatility.