Morgan Stanley’s PLUS ‘CAD’ notes tied to S&P/TSX 60 offer intriguing non-U.S. denomination

By Emma Trincal

New York, June 22 – Morgan Stanley’s 0% Performance Leveraged Upside Securities due June 2020 linked to the S&P/TSX 60 index caught the attention of some market participants because of the currency denomination in Canadian dollars. While registered with the Securities and Exchange Commission, the notes were not U.S.-denominated, a situation sources said is somewhat unusual in the U.S. structured notes space even if it is much more common in the plain-vanilla bond market.

The principal amount and issue price of each PLUS is C$ 1,000, according to a 424B2 filing with the SEC on June 18.

The payout at maturity will be par of C$1,000 plus 223% to 233% of any gain in the index.

Investors will be exposed to any losses.

Peculiar

A structured product market participant said the currency denomination was singular for a U.S.-registered note.

“I don’t see a lot of that,” he said.

Most foreign-currency-denominated structured notes are filed under Regulation S, lawyers said.

Regulation S offers an exclusion from registration requirements of the Securities Act of 1933 for offerings made outside the United States by both U.S. and foreign issuers.

Sources were wondering why an issuer would register a foreign-currency-denominated note with the SEC.

“It’s not natural for a U.S. client to buy a structured note in a non-U.S. currency,” said a U.S. sellsider.

“I know that some countries have agreements allowing them to distribute easily into the other country.”

An industry source said that “people do that all the time in the corporate bond market,” but that “it’s unclear how often it’s done with structured products.”

The notes are global medium-term notes.

Any issuer issuing a global medium-term note can choose a currency other than the U.S. dollar, legal sources explained. What was more unusual was the use of a foreign currency for a note issued from a U.S. shelf.

Target market

The main question was where the notes were likely to be marketed.

“It certainly can be sold in the U.S. There is no limitation to who it can be sold to,” the industry source said.

“Whether this is really targeted to U.S. investors is not known.”

The recent filing did not disclose currency risk. Some wondered why.

“From a note perspective, there is no currency risk, because you’re buying and selling in Canadian dollars.

“This note does not have currency risk. But if a financial adviser in the U.S. is investing for a U.S. client, they have to come up with Canadian dollars to buy the notes and at maturity convert the Canadian dollars back into U.S. dollar. You have to convert that in and out.”

Conversion

From the point of view of a U.S. advisor, the conversion aspect of the product had little appeal.

“There is currency exposure. When you go to Saks Fifth Avenue, you are not going to buy things in Canadian dollars. There is going to be some currency risk obviously,” said Steve Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management.

The underlying index, which is a large-cap Canadian equity benchmark, is denominated in Canadian dollars, so “it’s not a surprise” that the notes would be denominated in Canadian dollars, a market participant said.

The “surprise” was the absence of currency risk disclosure in last week’s filed document.

“Clearly, if a U.S. account invests, then there will be a conversion of CAD into USD. I’m a bit surprised there’s not more disclosure on the currency risk.”

“Since you can presume that some U.S. investors may want to buy the notes, why isn’t there a discussion or at least a nominal disclosure?”

A lawyer disputed this assertion, arguing that the disclosure was already in place.

“The disclosure of the currency risk exists. It’s simply in the base document,” he said.

He referred to the prospectus dated November 19, 2014, cited on top of the recent prospectus.

“Any risk associated with foreign-denominated currency will have to be disclosed there.”

The point of currency risk disclosure may be moot if the notes were to be sold to Canadian investors, an assumption sources and lawyers seem to make separately.

Canadian clients

“My guess is that they’re selling it to Canada. It’s registered in the U.S., and they can sell it to Canada with an exemption. It’s sold over there with a Canadian wrapper. This way they can take advantage of the fact that they don’t have to register in Canada,” a second lawyer said.

The “wrapper” is “a few pages of disclosure added to the base” document, he explained.

“They already have an existing registered program here, and it’s probably more appropriate for retail.”

The reasons for registering a global medium-term note in the U.S. were many.

“Sometimes investors like to see SEC-denominated offerings even though they’re offshore investors. We’ve seen that from time to time. There can be different reasons for it. Sometimes they like the fact that it’s under the SEC process,” the first lawyer said.

Exemption

“This type of offering depends a lot on investment demand. Other firms have done that before. Goldman Sachs has done that,” the second lawyer said.

The prospectus mentioned other countries such as Mexico, Brazil and Chile.

“The plan of distribution takes advantage of exemptions in these countries as well,” he said.

“It’s registered with the SEC. It’s in the base document. They won’t have to file in these countries.”

Lawyers said that they had no way to know for sure what the target market would be.

“I don’t know if the investor is offshore, but it’s likely. There aren’t many investors in the U.S. who would want a foreign-denominated investment. The investor could be currently located in the U.S. but still be offshore,” the first lawyer said.

“The fact that the introducing agent is based in the U.S. or that the deal is registered in the U.S. doesn’t necessarily mean that it’s going to be marketed in the U.S.

“It may not be broadly marketed at all.

“It could be sold to a Canadian fund located in the U.S.”

MSIP

Morgan Stanley & Co. International plc (MSIP), the agent for the offering of the PLUS, is not a U.S. registered broker dealer, according to the prospectus.

However the introducing broker, CAIS Capital LLC, is based in the U.S.

“This tells me that this deal is meant for outside the U.S.” the industry source said.

“It could have been sold to a Canadian private bank client for instance. CAIS could have simply introduced the client to Morgan Stanley.”

Morgan Stanley & Co. International plc is the agent, with Morgan Stanley & Co. LLC handling distribution.

The notes will price in June.

The Cusip number is 61761JZX0.

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