The deal to sell RBS' Asian businesses to Standard Chartered is looking a little shaky, and to be honest, I wouldn't buy either business on principle because of their willingness to fleece the naive Asians through what they call dual currency deposits, supposedly a source of high returns to investors, but in reality a scam from the derivatives trading floor.
I have never been a fan of retail structured products from UK banks. A typical scheme of 10 years ago was a share based investment with a guaranteed return of capital. 70% of your investment went back on deposit to secure the capital while the rest went in a tracker, and you were charged a fee on the whole amount.
The DCD which has been around for a while goes to another level of deviousness by offering suspiciously high rates of interest whilst embedding a currency option effectively written by the depsitor to the bank. The way it works is as follows: You deposit say $50,000 in one currency with the bank and nominate an alternate currency, usually quite weakly correlated, such as NZ$ and EUR. The deposit earns what appears to be a high rate of interest over a month, but at the end of the term the principal and accrued interest may be repaid in the original or the alternate currency, at the bank's option.
And guess what, at maturity the bank always chooses the currency that costs them the least, or in other words earns you the least. If you stop and think about it, the extra loss probably wipes out the extra interest earned on the deposit. In fact if you think a litle bit harder, you will realise that the bank is only doing this because on average, even after all the cost of the added complexity, it is making more money on the DCD than on conventional deposits.
In Europe the DCD is rarely seen, but in Asia it is surprisingly popular, but then so is gambling. Contrary to what Standard Chartered, RBS, HSBC, Citibank and all the other banks between the Gulf and Australia who push these things may say, they aren't sold to sophisticated investors.
Almost by definition, they are sold to people who don't understand the risks, or if they do, can't quantify them. They might be able to tell that 8% is a better rate of interest than 6%, but they probably have no idea whether over one month that interest differential is an adequate premium for a one month currency option. If a sophisticated investor really wanted exposure to the currency risks, they would probably have bought a different product.
6 comments:
Hmmm. If you want to buy a significant amount of a new currency (for example to buy a holiday home in a foreign country) and are not sure exactly when to do it because you don't know when the best time is, and you are happy to wait a bit because you're not in a hurry to do so, then a DCD is a good way of having the decision made for you: you get a higher interest on your home currency deposit while you wait, and if you get switched into the new currency well hey you wanted that anyway so you don't mind.
Oh, and you might be a private client so you're not big enough to interact directly with the markets.
So not quite so useless after all....
"not sure exactly when to do it because you don't know when the best time is"
Then perhaps no hedge is better. The time to hedge is when you know you are certain to buy. A refinement might be to hedge dynamically according to the likelihood of completing, provided you are willing to bear the possible cost of unwinding the hedge if you don't buy the foreign house.
But all that is far removed from the DCD, where you do not have any control over the exercise, so you never know which currency you will end up with - and where on average you should expect to end up worse off than holding the money on deposit in the normal way.
There are very few real life profiles that are hedged by the DCD - you would need to otherwise be in a position to profit from the depreciation of the alternate currency to make this work, but even then you would not do as well as you could dealing directly with the markets - which you can do; just ask your bank for details if you want to buy a currency option or forward.
I agree that most of what you say is probably correct, but then in the real world most ordinary private clients aren't as interested as we might be in the deepest intricacies of these things; and as soon as you, perhaps correctly, start talking about currency options or forwards (i.e. the dreaded "derivatives" aaaargh!) nine out of ten private clients that I know will be heading for the next county before you've even finished your sentence. So you won't even get the chance to explain at all that there may be a better way.
A DCD is a perfectly valid product if used in the right way: my example may be at least one where the client may see the package that it represents as worth it, and, perhaps more importantly, safe or unlikely to go drastically wrong. It also protects them somewhat from later seeing that they might have made a stupid decision because the decision is made for them by the markets, which is important too: animal spirits you see.
It may not be perfect but then very few financial products are - look at unit trusts for example - they can go down in value (sometimes alot) and on average everybody loses (not least because of the fee), but no-one realistically says that they are shockingly bad products.
I say they are shockingly bad products simply because they are sold dishonestly as high yield products whereas every swaps dealer knows there is no such thing as a free lunch. The punter is sold on the "high" interest rate without appreciating the risk in the embedded option.
"I say they are shockingly bad products simply because they are sold dishonestly as high yield products whereas every swaps dealer knows there is no such thing as a free lunch."
There's the rub: a sweeping dismissal by an expert who knows what he's talking about. Yet I hope I have have demonstrated above that it is perfectly possible to be a private banker trying as hard as one can to do one's absolute very best for one's client and for them both legitimately to come to the conclusion that a DCD might be an appropriately usefull thing for the client to use: and yet the experts will still pan the product, so inducing the client to believe his private banker is being duplicitous when in fact he's being quite the opposite.
Ho hum that's life I guess....
"Yet I hope I have have demonstrated above that it is perfectly possible to be a private banker trying as hard as one can to do one's absolute very best for one's client and for them both legitimately to come to the conclusion that a DCD might be an appropriately usefull thing for the client to use"
This is a classic case of a bank pushing what it wants to sell, in this case because its options trading desk sees how it can pull a fast one one its customers. Honestly, did you ever hear a customer say, "I would like a one month deposit facility where I get paid off in the worst performing of two currencies over the month"? Really?
Post a Comment