The Alchemy of Loss: How Banks Turn Complexity into Profit
The architecture of wealth extraction
The products go by names that suggest precision and sophistication: autocallable notes, conditional target redemption forwards, reverse convertibles, principal-protected securities. They arrive in the portfolios of retail investors and affluent individuals accompanied by glossy brochures, reassuring conversations with relationship managers, and the implicit promise that complexity itself is a form of value. What they deliver, with remarkable consistency across markets and decades, is loss.
The numbers are not ambiguous. In fiscal 2025, Indian retail investors lost 1.06 trillion rupees—roughly $12.5 billion—on equity derivatives, a 41 percent increase from the previous year. Ninety-one percent of participants finished in the red. In the United States, documented losses on structured products exceeded $1.5 billion in a single studied period. In France, 89 percent of retail clients trading contracts for difference reported losses; in Britain, 70 to 80 percent; in Australia and Ireland, 72 and 74 percent respectively.
These are not the odds of a casino. They are worse.
Complexity as extraction mechanism
The instruments banks sell to retail clients are not neutral investment vehicles. Their financial architecture serves a specific purpose: transferring risk from the bank’s balance sheet to the client’s portfolio while the bank retains control over pricing, liquidity, and the moment of settlement.
Consider the autocallable note—a product that has proliferated across wealth management platforms worldwide. It combines a bond with embedded barrier options. The client receives an attractive coupon, often 8 to 12 percent annually, provided the underlying assets (equities, indices, currencies) remain above specified thresholds. When those assets fall below the barrier, coupon payments cease, and the client becomes the holder of a deeply discounted equity-linked instrument with potential for total capital loss.
The key mechanism is the “autocall” clause, which permits the issuer to redeem the note early if the underlying assets perform well. The client participates in losses but has capped participation in gains—when the market rises, the bank calls the note and keeps the upside for itself. The payoff structure is asymmetric by design.
Or consider the conditional target redemption forward, known in the trade as a TARF. A client seeking to hedge currency exposure—a Polish exporter receiving payments in euros, say—receives a proposal for a contract allowing currency purchase at rates more favorable than spot. The catch lies in the activation conditions. When the exchange rate crosses a specified threshold, the client becomes obligated to purchase currency at loss-generating rates, and in quantities that may be multiples of actual business needs. The product presented as a hedge becomes a leveraged speculative position.
In May 2025, Reuters revealed that UBS was in discussions with approximately three hundred clients who had sustained losses on TARF products—some exceeding 50 percent of invested capital. Total client losses ran into the hundreds of millions of Swiss francs.
The structural conflict
Traditional securities markets separate functions: the issuer introduces the instrument, the market maker provides liquidity, the broker executes client orders. In structured products, the bank performs all these roles simultaneously.
As producer, the bank designs the instrument to maximize the value of embedded options it can sell. As distributor, the bank receives commissions often reaching 5 to 7 percent of transaction value annually—multiples of compensation for selling traditional instruments. As counterparty, the bank remains the client’s sole trading partner throughout the product’s life, controlling secondary market pricing.
This concentration of functions eliminates the market mechanisms that normally protect investors. The client cannot compare prices with competitors, cannot exit the position without the bank’s consent, cannot independently verify valuation.
The compensation structure for advisers compounds the problem. Structured products generate commissions of 5 to 7 percent annually; traditional index funds generate 0.1 to 0.5 percent. A rational adviser maximizing personal income will recommend structured products regardless of client suitability. Empirical research confirms the mechanism: adviser recommendations correlate with implied volatility of underlying assets—a parameter determining product profitability for the bank—rather than with the client’s risk profile or investment objectives.
Regulatory requirements for information barriers between sales and proprietary trading remain porous in practice. Credit teams routinely share information with derivatives traders to ensure “correct pricing,” creating a formal channel for non-public client position information to influence trading decisions. During the 2008 crisis, Goldman Sachs simultaneously sold clients products based on mortgage credits while taking opposite positions for its own account. Internal emails revealed during congressional hearings showed bank employees describing the products they were selling as “shitty deals”—while continuing to distribute them.
The hedging dynamic
When a bank sells a structured product to a client, it must hedge its own exposure by taking the opposite position. As markets move, the bank is forced to continuously adjust this hedge—a process that generates costs known as “negative gamma.”
In volatile environments, hedging costs accumulate substantially. The bank, rather than extracting the full economic value from sold volatility, incurs hedging losses that it partially transfers to the client through unfavorable product pricing.
As one Société Générale trader put it: “We sit, fingers crossed, hoping the market does not move too much.” The client bears the consequences of this uncertainty, though the product was presented as a stabilizing instrument.
Structured products are not exchange-listed and lack liquid secondary markets. The only buyer before maturity is the issuing bank, which has no obligation to repurchase or quote prices. This traps the investor in an illiquid position precisely when exit is most needed—during market downturns. When the client attempts to sell, the bank sets the price according to its own internal models, with spreads systematically favoring the institution.
The hidden costs
Comprehensive analysis of structured products reveals systematic underperformance. Autocallable notes returned an average of negative 4.4 percent annually compared with S&P 500 performance. Reverse convertibles were overpriced by 7.8 percent relative to fair value. The aggregate structured product index showed overpricing of 5.9 percent.
These differences do not result from unfavorable market conditions—they are built into product construction. Fees embedded in the structure, often 5 to 7 percent annually, and option valuations unfavorable to the client systematically transfer value from investor to issuer.
Leverage amplifies the dynamic. A 10 percent price decline on a 4x leveraged position means 40 percent loss on invested capital. In conditions of elevated market volatility, leveraged positions are subject to automatic liquidation through margin calls, forcing the investor to realize losses at the worst possible moment.
Why regulation fails
Regulatory frameworks require formal legislative processes lasting 12 to 24 months. New derivative products are created and mass-distributed within weeks. Regulators are perpetually fighting the last war.
The SEC’s 2020 directive ordering a study of risks associated with leveraged ETP products has yet to produce concrete rules. FINRA continues gathering opinions on the adequacy of existing regulatory frameworks—five years after identifying the problem.
Penalties, though significant in absolute terms, remain marginal relative to generated profits. A bank handling hundreds of billions in daily currency transactions can incorporate a penalty in the low hundreds of millions as a cost of doing business. The expected value calculation often favors continuing improper practices: the probability of detection multiplied by the penalty amount remains lower than profits from distributing unsuitable products.
Regulations protecting retail clients—leverage limits, negative balance protection, mandatory risk warnings—often explicitly exclude small and medium enterprises and corporate clients. These entities remain unprotected despite financial literacy levels no higher than those of consumers. Deutsche Bank sold unsuitable products to Spanish corporate clients for three years before the regulator identified irregularities. The delay between misconduct and intervention allows losses to accumulate.
Models that work
Belgium and Portugal have implemented effective bans on selling structured products to retail clients. The solution eliminates the problem at its source: products designed to extract value from inexperienced investors simply do not reach that customer segment.
Australia and Ireland have deployed Design and Distribution Obligations frameworks requiring issuers to define target customer segments, document that customers possess required knowledge and experience, demonstrate that the product delivers fair value to target customers, and conduct regular reviews of distribution adequacy. These frameworks explicitly acknowledge that many structured products fail the fair value test and should not be distributed to inappropriate customer segments.
The SEC has developed Value-at-Risk methodologies measuring risk relative to equity benchmarks. Adopting objective VaR-based complexity thresholds would replace subjective classifications with measurable risk parameters, automatically restricting distribution of products exceeding specified values.
The zero-sum transfer
The fundamental problem is not information asymmetry that better disclosure can solve. The problem is structural: these products are designed to extract option value from retail investors on behalf of issuing banks.
The volatility that banks hedge at cost is the same volatility from which they profit through product sales—a zero-sum transfer mechanism that compounds client losses. Without structural change—whether through retail distribution bans, mandatory independent client representation, objective complexity thresholds with automatic distribution restrictions, or forced separation of advisory operations from proprietary trading—retail investor losses from bank-sold derivatives will continue accumulating.
The data from India, the United States, and recent institutional cases suggest that current regulatory frameworks provide inadequate protection, and that the scale of retail losses may be materially underestimated in official figures.
The cycle repeats. The next scandal is already in preparation.
Founder and Managing Partner of Skarbiec Law Firm, recognized by Dziennik Gazeta Prawna as one of the best tax advisory firms in Poland (2023, 2024). Legal advisor with 19 years of experience, serving Forbes-listed entrepreneurs and innovative start-ups. One of the most frequently quoted experts on commercial and tax law in the Polish media, regularly publishing in Rzeczpospolita, Gazeta Wyborcza, and Dziennik Gazeta Prawna. Author of the publication “AI Decoding Satoshi Nakamoto. Artificial Intelligence on the Trail of Bitcoin’s Creator” and co-author of the award-winning book “Bezpieczeństwo współczesnej firmy” (Security of a Modern Company). LinkedIn profile: 18 500 followers, 4 million views per year. Awards: 4-time winner of the European Medal, Golden Statuette of the Polish Business Leader, title of “International Tax Planning Law Firm of the Year in Poland.” He specializes in strategic legal consulting, tax planning, and crisis management for business.
