Paribas debuts property derivatives index basket trade
BNP Paribas has priced the first property derivatives trade based on a basket of indices. To date, property derivative trades have been based on single indices but the Paribas trade signals a new direction for the market, and more basket trades are expected to appear.
The trade, completed in May, was developed as a component in a property-linked structured note that Paribas’ client Den norske Bank created for retail investors. The retail note gives exposure to three different indices, Germany, France and UK, as a proxy for European property exposure. Paribas structured an option on the Germany, France and UK IPD property indices to give DnB some protection on the amount their clients invested in the retail note.
"The protection is on the downside so they can offer their clients a principal-protected product," explains Andrew Jeyarajah, a property derivatives structurer at Paribas in London. "The option will pay out to their clients an average return across those three indices for the life of the option."
One of the keys to being able to complete such a trade is a bank’s willingness to take on property derivative exposure, which Paribas is able to do. The French bank has been active in property derivatives for the past nine months and is seeking to expand its business in single indices as well as baskets of indices.
"It’s a function of the bank’s appetite for property derivatives," says Jeyarajah. "Not everyone would be able to do it, simply because you have to be able to warehouse that option position. It’s not like we can go and hedge ourselves in the market because options aren’t trading in the market yet. We have to be innovative in our approach to managing the risk and finding solutions for customers which help offset our exposure."
Generally, basket trades have been slow to take off. Jeyarajah says that since the DnB trade in May, Paribas has received many enquiries on the basket structure but continues to see more interest in the single-index product.