Barclays' buffered return enhanced notes linked to Nikkei use Asian option to improve pricing

By Emma Trincal

New York, Feb. 19 - Barclays Bank plc's 0% buffered return enhanced notes due Feb. 26, 2018 linked to the Nikkei 225 index have an unusual structure allowing issuers to offer a product with unlimited upside and a sizable buffer, sources said. In addition, the issuer plans to offer some upside leverage, albeit at a very moderate level.

If the index return is greater than or equal to negative 25%, the payout at maturity will be par plus 1.03 to 1.13 times the average index return. The actual participation rate will be determined at pricing, according to a 424B2 filing with the Securities and Exchange.

If the index return is less than negative 25%, investors will receive an amount equal to par (i) minus 1.3333% for each 1% decline beyond the 25% buffer (ii) plus 1.03 to 1.13 times the average index return.

The average index return is calculated using the average of the index closing levels on each of 16 quarterly observation dates and cannot be less than zero.

Technically doable

"Two things: you look at the final index return, and you look at the average return. It's interesting," a structure said.

"From a technical perspective, it's definitely doable, it's technically priceable. It may take a while to explain to a client depending on who the client is. It's a play not just on what the final level is going to be but on the average itself.

"I haven't seen that type of structure. But I can see the reason behind it: pricing."

Two types of return

The prospectus illustrated the notes' payout in a hypothetical scenario under which the final index return was negative 30%, the average index return was 10% and the upside leverage factor was 1.03.

Since the final index return was less than negative 25%, investors would lose the difference between the negative 30% final return and the buffer amount of 25% multiplied by the downside leverage factor of 1.333, which resulted in a 6.665% loss. But the upside component of the deal offered a positive return. The 10% average return, multiplied by the 1.03 upside leverage factor, gave a 10.3% positive return.

Adding both components led to a 3.63% gain despite the hefty 30% decline in the final index level.

In this case, the impact of the positive average index return offset the negative final index return, resulting in a positive return on the notes, explained the prospectus.

Asian option

"On the upside, you're getting the average return. It's an Asian deal. You don't apply the upside leverage on the final return. You apply the upside leverage on the average return," the structurer said.

He was referring to the term "Asian options," which designate options based on the average price of an underlying at different observation dates.

This structurer said that the use of an Asian option helped improve the terms of the deal by giving investors upside leverage, no cap and a larger buffer.

"This structure is a way to get better pricing," he said.

"It's cheaper for an issuer to give you the average on the upside. That's because there is less time to play with. If you have a four-year, point-to-point, there is more time value, the stock has a greater chance to go higher. That's why the call would be more expensive on a point-to-point.

"But here, with the Asian option, the call is worth less money. If I buy a call option, the less time I have, the less valuable the option is."

Selling high

By using both the average return and the final return, the issuer was able to improve pricing on both ends of the deal, he explained.

"On the downside, they're giving you the final index return. That, on the other hand, is more expensive," he said.

"What you're getting on the downside is more valuable.

"Bottom line: you're buying cheap and selling dear. It makes the product more attractive.

"It's a way to give you a cheaper upside while at the same time selling a more expensive downside. Your structure is going to show more attractive terms as a result of this. This is probably the rationale behind the structure."

This structurer said that one possible "improvement" was the ability to offer leverage.

"They were able to give you a better leverage factor, although I have to say that 1.03 to 1.3 is not that much. But can you imagine not having it?" he said.

Variable coupon-like

A market participant explained that the original structure could be compared to a reverse convertible with a variable coupon.

"You have two components. The averaging option is positive under all circumstances. That tells us that we have an average return that could be zero or something positive. It's like a variable coupon. This is something you get regardless," he said.

The "second component," he said, is the final return.

"Now, whether you get your principal back or not depends on something different. It's based on the final level. You either don't breach the buffer level and you get par if it's negative or you breach it and your return is tied to the amount of decline beyond the buffer times the downside leverage factor.

"In both cases you get the average return, which could be zero or something positive. It's almost like a reverse convertible except that the upside is not a coupon but a variable amount from zero to a something positive and it derives from the averaging option."

Return enhancement

The market participant agreed that using the averaging option is a way to enhance the return.

"If they gave you the final return on the upside, they wouldn't have been able to give you a 25% buffer. But because you get the averaging upside, it's cheaper. Therefore, they can incorporate a much bigger buffer. And that's what they did," he said.

However, there is a tradeoff for investors.

"If you want that 25% downside protection, you have to settle for a more scaled downside compared to what you could get point-to-point."

Customized deal

This market participant noted the absence of fees, according to the prospectus.

"This tells me that the products must have been directly designed for an end-client, most likely an institutional client or [a registered investment adviser] buying directly from Barclays. This was not a deal created for external distribution," he said.

"I don't think I've seen that kind of structure before. It's interesting to have the averaging on the upside ... the 25% buffer with the geared downside, all that in one product.

"It's not breaking new grounds, but it's definitely interesting. I'm pretty sure it was customized for a particular client."

Issuers are becoming more creative in fine-tuning their products to better fit their clients' needs, he noted.

"I don't know if this thing will repeat itself. They were probably dealing with a conservative client looking for a good buffer with unlimited upside. That's one way to do it, and Barclays came up with the structure to fit those requirements."

Barclays is the agent.

The notes will price Friday and settle Feb. 26.

The Cusip number is 06741T6A0.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.