HSBC’s $122,000 buffered leveraged notes on S&P 500 ESG index tap into popular theme

By Emma Trincal

New York, Dec. 23 – HSBC USA Inc.’s $122,000 of 0% buffered Accelerated Market Participation Securities due Dec. 23, 2022 linked to the S&P 500 ESG index provide investors access to an investment style that is popular in the mutual fund industry but not widely used yet by structured notes investors despite growing demand.

If the index return is positive, the payout at maturity will be par plus 200% of the index return, capped at par plus 14.5%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by 10% or less and will lose 1% for every 1% decline beyond the 10% buffer.

The S&P 500 ESG index is designed to align investment objectives with environmental, social and governance (ESG) values.

The index screens the S&P 500 index first by eliminating tobacco and “controversial weapons” stocks. It then scores stocks based on environmental, social and governance data using quantitative models based on the normative principles of the United Nations Global Compact, known as UNGC scores. Any company with a UNGC score at or below the bottom 5% of the UNGC score universe is excluded.

Other indexes

MSCI offers several ESG indexes such as the MSCI ESG Leaders, the MSCI ESG Universal and the MSCI Climate Change with a separate equity and fixed-income version for each of them. The index provider has about 15 other formulas offering a more granular approach to ESG investing.

Other little-known benchmarks exist, but they tend to be proprietary.

In April 2018 for instance, BNP Paribas partnered with Research Affiliates to create a smart beta index called RAFI ESG strategy.

Slowly gaining traction

“There’s so much talk about ESG types underlying. It seems to finally resonate as we see an explosion of benchmarks. People actually care about impact investing. We hear about institutions inquiring about it. Some of them are mandated to allocate some funds into the strategy. And yet, it’s still not really mainstream,” said a sellsider.

“Until many more people want to put money in ESG, I’m not too sure that what’s good for the world is necessarily going to be a good investment theme.

“It’s not like buying sectors. Sectors have an underlying financial theme. For instance, tech stocks this year did well because it was the stay-at-home play. Energy would rely on oil prices among other factors. But what’s the investment theme with ESG? Unless it really takes off, I’m not convinced that what’s good for the world is necessarily a good source of return.”

“You would need to see more mandates, more inflows, something really mainstream. The buzz is that we’re getting there. But it’s still very slow.”

Regarding the structure, he said the 14.5% cap “is a little low,” but that having the 10% buffer was a good thing.

“It’s a conservative play,” he said.

Not many benchmarks

HSBC has been the principal issuer of notes tied to the S&P 500 ESG index. Volume in general is still thin. For one thing, the index began publication on Jan. 28, 2019. Second, it’s only since September that Cboe Global launched cash-settled options on the index, a condition necessary to implement hedging and asset allocation strategies.

Tradable options

“I think the fact that we now have this broad index should help,” a market participant said.

“So far, issuers were hedging with the S&P 500 index options. The ESG and the S&P 500 may not be fully correlated. It limits pricing. The new options on the S&P ESG index are probably very helpful. We should see more issuance of notes as a result. But it’s still a young market.”

However, this market participant was not a big fan of the S&P 500 ESG index construction methodology.

“Sometimes they let some stocks in like Halliburton. Haliburton is an oil company. Not sure it’s environmentally friendly. But the company, like many other oil companies, claim to offer environmentally friendly solutions like clean water in the case of Haliburton. So, they pass the test.”

Small and nimble

Another limitation faced by broader sustainability benchmarks is precisely their breadth: one size does not fit all.

“Someone may be focused on the environment and they may not care so much about filtering out tobacco stocks for instance,” he said.

“Everyone likes the concept of ESG investing. But it’s too vague. Picking the stocks is a matter of personal preference.”

This is why he recommended using baskets of stocks as underliers instead of indexes.

“Structured notes offer the flexibility to design your own portfolio.

“You can find more creative ways to create your underlying basket of stocks without sacrificing the terms.”

HSBC USA Inc. is the agent.

The notes settled on Wednesday.

The Cusip number is 40438CF48.

The fee is 0.8%.

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