Structured Issuer RankingMarch 20, 2017 - 13:57
One of the main problems facing investors in structured products is to determine which issuer to use. It is obvious that issuers with higher Credit Default Swap (CDS) levels will in the main offer better terms than issuers with lower CDS levels, but it can be difficult to work out if the additional terms on offer are sufficient to compensate for the additional risk.
In order to help investors identify which banks are offering the best "value" we use our fair value calculations to rank the active issuers in the market based on the published prices of existing products.
Our starting point is that for all of the products where we calculate a fair value we use a funding fraction equal to 50% of the issuers CDS curve where there is a capital-at-risk or the product is callable, and 100% for all other products. Across the whole market using these fractions our fair values are in-line with the traded prices published by the banks. Some prices are above our fair value, while others are below, but on average these are the funding fractions that make our fair values on average correct. (Note: it is perfectly reasonable for a bank to issue structured notes using a level of funding less than their CDS rate, or the level that they would use for a vanilla issue. The issuer of a structured product is generally offering daily liquidity, additionally the risk to capital and uncertainty over the maturity date means that the issuer has far less certainty about the money that they have raised, or the tenor of the note. This means that the cash raised is less valuable to the issuer, and this is reflected in the reduced funding that they offer.)
What we want to do is to offer more detail so that we can better estimate the pricing we will get from each issuer, and also to help identify which issuers are offering the best "value". Our goal is to calculate an implied level of funding used by each bank. We also want to be able to estimate the other invisible variables that go into the pricing models; correlation between equity markets, and the correlation between equity markets and foreign exchange rates.
FTSE BASED IMPLIED FUNDING
If we use a standard volatility surface, the published prices of FTSE only products allows us to calculate the implied GBP funding being offered by each issuer. We can then use this implied funding to work out how much we need to adjust our standard funding assumption for each issuer. The implied funding fraction is the fraction that causes the Fair Value we calculate to equal the published bid price of the product. Finally we rank all of the issuers based on the adjustment factor.
SX5E PRODUCT: FUNDING AND CORRELATION
If we now look at deals linked to the SX5E only we can rank banks by the implied correlation between SX5E and EURGBP, and then by the implied funding for these deals.
FTSE SX5E PRODUCT
FTSE SPX PRODUCT
FTSE SX5E SPX PRODUCT
Source: Investment Product Research 20 March 2017
David has been involved in equity derivatives, equity structuring and the structured product market for over 25 years. Before setting up CUBE in 2013 David worked at J.P. Morgan, Barclays and RBS. David has worked with and for retail product providers, discretionary managers and institutional investors.