Barclays’ digital notes due 2019 tied to 10-year ICE swap rate tap into equity structure type

By Emma Trincal

New York, July 24 – Barclays Bank plc’s 0% digital notes due Aug. 14, 2019 linked to the 10-year U.S. dollar ICE swap rate offered unusual terms for a rate-linked product, applying the classic buffered digital structure seen with equity underliers to a rate deal.

If the swap rate finishes at or above its initial value, the payout at maturity will be par plus a digital return of 7.2%, according to a 424B2 filing with the Securities and Exchange Commission.

If the rate falls but finishes at or above the 70% downside threshold, the payout will be par.

Otherwise, investors will be fully exposed to any losses.

Rising rate environment

“The general consensus is that interest rates will go up in the next 12 months and I don’t see any reason why they wouldn’t,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

In fact, even if rates stayed as they are now, investors would still get paid the digital return.

“Rates would have to go down, and I don’t see that happening unless we have a recession. But the probability for a recession in the next year is low in my opinion.

“There will be some issues potentially. But the economy is strong and the Fed will continue to raise rates,” Chisholm said.

Favorable probabilities

Investors therefore are likely to get their 7.2% return at the end of the one-year period. But Chisholm said it was not necessarily a very exciting return.

“It’s fine but it’s not great,” he said.

However, the distribution of probabilities was satisfying.

“It’s a play on interest rates with reasonable chances that the outcome will be favorable.

“So even though the potential return is not that high, you have a good probability to get paid.

“In that regard, the note isn’t bad. It has a fair risk-reward profile,” he said.

Wrong impression

A market participant who specializes in rate-linked products was cautious about the product due to its lack of full principal-protection.

“Stocks are meant for growth and therefore they are more speculative, they involve more risk. Bonds on the other hand are meant to mitigate risk and to balance your portfolio,” he said.

“So when I see a note linked to a rate that pays a coupon at maturity, for a lot of investors, it looks like a bond. But it’s just as risky as equity. I don’t go for it.”

Asked how such misperception of risk should be different from equity-linked notes, which are also debt instruments, he said that products tied to an interest rate can be much more confusing for investors who may easily assume they are purchasing a bond.

It’s the underlying

“Look, if you buy a note tied to Amazon or the S&P, you know what you’re buying. It’s equity. But when you show something tied to the 10-year Treasury, the 10-year CMS or any other rate with principal at risk, that’s when things start to get hairy,” he said.

He conceded that the risks are clearly disclosed on the prospectus. Unfortunately, clients do not always read it.

“In the back of their minds, when people see something tied to a rate, they think it’s a bond! You tell people to read the prospectus of course. But trust me...I’ve been doing this for decades. I’ve dealt with smart people. As soon as people lose money they’re like...’nobody told me that’... ‘I can’t read 50 pages...I’m a busy guy.’”

10-year ICE swap

The swap rate is the 10-Year U.S. dollar ICE swap rate, which is the fixed rate of interest payable on a U.S. dollar interest rate swap with a 10-year maturity, according to the prospectus. It is one of the market-accepted indicators of long-term interest rates.

The rate for the 10-year treasury is very similar to the 10-year U.S. dollar ICE swap. Those on Tuesday were at 2.95% and 2.99%, respectively.

A historical table in the prospectus showing the quarterly closing levels of the swap rate from Jan. 1, 2013 to July 1, 2018 gave an idea of its moves. The biggest decline took place between Jan. 1, 2013 and Jan. 1, 2016 with a 16.95% drop to 1.666% from 2.006%. But this was a three-year period. The second largest decrease was between January and July 2016. The 10-year U.S. dollar ICE swap rate fell 13.81% during this six-month period to 1.436% from 1.666%.

Barclays is the underwriter with JPMorgan as placement agent.

The notes will price on Friday and settle on Aug. 1.

The Cusip number is 06746XJZ7.

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