HSBC’s $4.36 million AMPS linked to FTSE China Large-Cap ETF offer bet on China’s turnaround

By Emma Trincal

New York, Jan. 26 – HSBC USA Inc.’s $4.36 million of 0% Accelerated Market Participation Securities due Jan. 26, 2018 linked to the iShares FTSE China Large-Cap exchange-traded fund represent a short-term play on a Chinese stock market recovery for investors comfortable enough with currently low valuations to invest in a non-protected note.

Rather than focusing on the downside exposure, sources emphasized the capped upside as the main risk to consider given how much the Chinese equity market has already declined.

If the ETF return is positive, the payout at maturity will be par plus double the ETF return, subject to a maximum return of 53.265%. Investors will have one-for-one downside exposure to any negative ETF return, according to a 424B2 filing with the Securities and Exchange Commission.

Chinese stock markets are in a deep bearish trend. Since a peak in April 2015, the fund share price has dropped 43%. Just for the year, or approximately the past three and a half weeks, the fund has already lost nearly15%.

Timing the bear

“It’s kind of interesting. I guess it’s always the same debate around a bear market. Have you reached a support, or should you expect more price depreciation?” said Jonathan Tiemann, founder of Tiemann Investment Advisors.

“If you think China was kind of beaten up and that it will go back up but not as much as it used to, that’s basically the view. You expect the index to go back up and to recover somehow but not to its previous levels. Then that’s your play.”

But no one knows at this point whether Chinese stocks have reached a bottom or not, he said.

“The trickier problem is you got into it and decide you were wrong because the market goes off in some terrible way. Well, then as always with structured notes, you’re stuck. It’s a two-year, so you’re not stuck for a long time, but you’re stuck for longer than you would want to be,” he added.

The 53.26% cap represents a 24% annual return on a compounded basis. The underlying fund would have to rise 26.63%, or 12.55% a year, to provide investors with the maximum return.

“I’m guessing the cap is fair. You sold some call options and the cap is your strike,” he said.

“The issuer has bought two times the underlying to give you the leveraged exposure on the upside. They sold two calls at 53% over the initial price. That’s your cap. And they bought an at-the-money put, which gives you the one-to-one exposure on the downside. For the issuer, the cost of putting up a hedge on this structure is probably reasonable as they’re on the other side.”

Leverage and risk

The asymetrical exposure – two-to-one on the upside and one-to-one on the downside – was an attractive feature compared to a direct investment in the fund, he said. But it was not a good substitute for liquidity or protection.

“I guess it may work for someone who is bullish and who is willing to commit to a two-year period. But there’s not much room for error,” he said.

“My issue with structured notes is always liquidity.

“You’re taking on the issuer’s credit risk, and you’re stuck if the index moves against you.

“You have to ask yourself if you’re getting compensated enough for that.

“With this product, you do get the upside leverage and you don’t get downside leverage. That’s good. But you’re giving up liquidity, dividends and some of the upside without benefiting from any protection.

“I’m not crazy about it.

“The risk mitigation piece is missing here because you can’t expect to be able to trade out.

“Also there is something a little odd about the view. The ideal scenario for someone who would buy this would be a moderate rebound in China. It’s an odd thing to bet on with respect to China.”

Opportunity cost

Win Thin, senior currency strategist at Brown Brothers Harriman & Co., focused on the risk of missing a future rally.

“You get a 53% limit over two years. If the index is up by more than 12.5% a year, you’re left behind. In that case you would have been much better off with the ETF.

“Imagine the index bounces back with the types of returns it used to show. You would be lagging behind the ETF a lot.”

Prior to its sharp decline, the FTSE China Large-Cap index jumped 30% last spring in less than six weeks.

“You are not just betting on a market recovery. You are betting on a range of return. It’s got to be X amount of return. I don’t know if you can get that fancy with this particular asset class. It’s a very narrow window. Chinese stocks can move 12% in a week. You’re taking the risk of missing out on a large bounce back.”

The odds of a rally within the next two years are high, making the choice of a capped instrument relatively unattractive compared to a direct investment in the fund.

“I think two years will give Chinese stock markets enough time to recover, and given the bearish market we have, you may really get a strong rebound. There’s too much of a risk of missing the opportunity with that cap, especially given current valuations.”

The notes (Cusip: 40433UGH3) priced on Jan. 21.

HSBC Securities (USA) Inc. was the agent.

The fee was 1.5%.

© 2015 Prospect News.
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