JPMorgan’s capped return enhanced notes linked to pound vs. euro introduce new currency pair

By Emma Trincal

New York, July 29 – JPMorgan Chase & Co.’s upcoming 0% return enhanced notes due Aug. 19, 2016 linked to the performance of the British pound relative to the euro make for the first use of the British pound as a reference currency in a structured note, according to data compiled by Prospect News since October 2006.

The British currency has been used in currency baskets before but not as a standalone currency against another one, including the dollar or the euro, according to the data, which tallies structured notes registered in the United States.

The timing of the underlying trade, however, makes sense.

“With the Bank of England likely to raise rates and the European Central Bank’s asset purchase program to continue, sterling appreciation versus euro is widely anticipated,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

One off

The payout at maturity will be par plus 2.16 times any currency gain, up to a maximum return that will be at least 10.8%, and investors will be exposed to any losses, according to a 424B2 filing with the Securities and Exchange Commission.

“I haven’t seen the British pound against the euro. I’m not familiar with that relationship,” a structured notes market participant said.

The most recent currency-linked notes offer exposure to the dollar versus the euro. The Mexican peso versus the dollar and the peso versus the euro are also commonly seen pairs.

“I don’t think it’s going to be a big offering,” said an industry source.

“These currency notes are not in very high demand. This is probably a bespoke deal.”

Currency-linked notes constitute as an asset class the weakest corner of the U.S. market. Agents have only priced 43 deals totaling $281 million this year, a mere 1% of the total volume, according to the data.

Euro bears

“This product is probably more about a weaker euro than a stronger pound with what Europe is going through,” the market participant said.

Investors are fully exposed to the downside while a fair amount of currency notes are buffered, sources said.

“It’s like with any note. The protection has to do with the characteristics of the underlying. Commodities and currencies notes are tied to what the forward contracts are telling you about the underlying. It may or may not allow you to buy the protection,” the market participant said.

Clemens Kownatzki, independent currency and options trader in Los Angeles, agreed that the deal may be more about the base currency – the euro in this case – than the reference currency.

“It’s probably more of a bearish bet on the euro with what’s going on with Greece and the possible repercussions on other euro zone countries,” Kownatzki said.

“The consequences of Greece leaving the euro are probably already priced in. If Greece leaves the euro, the focus will be on Italy, Spain and Portugal.

“I’m not sure it’s a bearish bet on the economic strength of the euro zone. You’re only looking at a one-year note. It’s a bit short for an economic bet. But the continued tensions in Europe could be a negative for the euro even short-term. The theme is there.”

Risk-reward

The structure is more problematic.

“I have no problem with the underlying view. The problem I have with this note is the downside,” he said.

“I have a 10.8% cap, but my downside is unlimited. Yes, they give me 2.16 leverage. But I can only make 10.8% while I can lose 100%.

“The pound is one of the most volatile currencies among other developed countries.

“If I’m going to settle for a full downside exposure, there are better alternatives. If I want to introduce leverage and even choose how much leverage I want, I can use futures and forwards contracts. This way my upside won’t be capped. I can make it shorter, for instance buy three-month contracts, and roll the position.

“I just don’t like having a cap when I can lose my entire investment. It’s not a good risk-reward scenario.”

J.P. Morgan Securities LLC is the agent.

The notes will price on Friday and settle on Aug. 5.

The Cusip number is 48125UUC4.

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