Structured products volume picks up ahead of Brexit; volatility puts reverse convertibles in focus

By Emma Trincal

New York, June 22 – Agents sold $294 million of structured products in the week ended Friday, a 22% jump from the prior week, as distributors showed short-volatility products as well as European-based investment ideas ahead of this week’s referendum in the United Kingdom, according to sources commenting on data compiled by Prospect News.

The market was volatile and closed slightly down last week ahead of the looming U.K. Brexit vote, which will determine whether this country will remain in or leave the European Union. The week also ended on quadruple witching – the simultaneous expiration of stock and index futures and options contracts – which pushed up both volume and volatility.

Fears about slowing economic growth continued to weigh in as the Federal Reserve scaled back expectations of rate hikes.

Brexit in focus

Sellsiders saw last week’s sudden spike in volatility as an opportunity to present investors with a “story” but also better terms. But they were skeptical about volume trend for the year.

“Volatility has been more elevated, especially short-dated volatility. We’re seeing coupons on these autocallables a bit higher,” said Tom May, partner at Catley Lakeman Securities, commenting on last week.

Reverse convertibles with a fixed coupon, autocallable contingent coupons and autocallables paying a call premium accounted for 45.5% of total volume. As always, the bulk of it (36%) went into autocallable contingent coupons, according to the data. A great number of those deals employed worst-of payouts.

Agents focused on underliers likely to feel the impact of the U.K. vote regardless of the outcome by giving investors access or partial exposure to European stocks, according to the data. Such offerings represented a third of the volume, or the equivalent of the notional tied to the S&P 500 index.

European-based

The EAFE index, which gives exposure to developed markets excluding the U.S. and Canada, was widely used. European countries make for more than 60% of this benchmark. The U.K. is the second largest geographic constituent with 20% of the total, after Japan.

The EAFE, either alone or in combination with U.S. equity benchmarks, was an underlying theme behind more than 13% of the total priced. The Euro Stoxx 50 index, when used alone or with other equity indexes, accounted for 19% of the total.

Ahead of the vote

“There’s an element of gambling in doing deals ahead of the vote. The polls are quite even. We’ll see where we are [Thursday],” said May.

The market implications of the vote were more significant on one side, he noted.

“I don’t think it will jump if they vote to stay. In the past few days some polls have titled toward the ‘remain’ vote. We’ve had a rally and some of that has already been priced in,” he said. “But if there is an exit vote, the market could drop a lot. I see more room on the downside than on the upside.”

He said that trading ahead of the June 23 vote was not wise. In fact, he saw little demand for structures based on the Brexit bet.

“We’re dealing with long-term investors in this market. I don’t see much interest for this type of gambling,” he said.

Year still down

For the year, volume remained slow at $16.48 billion as of June 17, a 26% decline from last year, the data showed.

“You have two factors that have put the brakes on volume in the past couple of months: the market and the Brexit vote,” he said.

The market has gone through up and down moves, but the trend is not bullish, he said.

“Nothing is calling. They don’t have that principal that they usually reinvest,” he said.

He was referring to investors who bought autocallable notes at a time when prices were higher. As a result, automatic calls have not been triggered this year.

“There is no reloading in the system. Investors just sit and wait for the autocalls.

“We don’t get many new trades. That’s why volume is down in equity. It’s really market-driven.”

Sold, not bought

A sellsider also pointed to market conditions, saying that low volatility and low interest rates were a drag on new business. In that regard, last week presented a pricing opportunity.

“You have to sell those out-of-the money puts, which is probably why you saw a lot of coupon notes. There are no other ways to get any kind of yield. You have to take on risk,” this sellsider said.

Describing himself as “cynical” he said that the Brexit theme was “just another marketing” idea.

“There’s very little to do. Everybody is desperately trying to push these products. When comes something like Brexit, it’s an obvious marketing theme. People buy ideas. At the end of the day, it’s going to be business as usual in two weeks... there will be another story, the next new thing because those products are being sold, not bought.”

Tiny winners

Top deals were small, with the largest one at $23 million.

JPMorgan Chase Financial Co. LLC priced $23.06 million of four-year callable contingent interest notes linked to the lesser performing of the Russell 2000 index and the S&P 500 index.

The notes were guaranteed by JPMorgan Chase & Co.

The contingent coupon payable every six months but observable quarterly was 5.25% per annum if the worst-performing index closed at or above its trigger value of 50% of each index initial price. The barrier at maturity was at the same 50% level.

The notes were callable at par plus the contingent coupon on any interest payment date.

Canadian Imperial Bank of Commerce priced the second offering with $22.62 million of 0% two-year leveraged notes linked to the Euro Stoxx 50 index.

The leverage multiple was three with a 24% cap. Investors were exposed to any index decline.

BofA Merrill Lynch was the agent.

Finally the third deal was Royal Bank of Canada’s $16.6 million of three-year trigger callable contingent yield notes linked to the lesser performing of the Russell 2000 index and the S&P 500 index.

The contingent quarterly coupon was 8.15% per annum based on a 70% coupon barrier. The notes were callable at par on any coupon payment date after six months.

The barrier at maturity was also 70%.

UBS Financial Services Inc. and RBC Capital Markets, LLC were the agents.

The top agent last week was JPMorgan with 20 deals totaling $95 million, or a third of the volume. It was followed by Bank of America and HSBC.

“Volatility has been more elevated, especially short-dated volatility.” – Tom May, partner at Catley Lakeman Securities

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