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Equity derivatives: Investors fear structured note counterparty risk

Investors in equity-linked structured notes are becoming increasingly concerned about counterparty credit risk, and are therefore becoming more discerning when it comes to choosing which institutions to buy their products from, report dealers.

Shane Edwards, Royal Bank of Scotland

"Investors are looking at bank A, for example, that might be offering 130% participation and comparing it with another bank, B, that is offering 110% participation, but they’re asking what their chances are of actually getting their money back with bank A"
Shane Edwards, Royal Bank of Scotland

"More people are paying attention to credit risk than before, so it is true that the subset of investors that are being particularly prudent has increased," says Alberto Cherubini, head of exotic equity derivatives at Citi in London.

Whereas in the past many investors, especially retail investors, would have been primarily focused on the payoff that the structured note provides, with credit markets looking so shaky attention is now also being focused on the creditworthiness of the seller of the note. This could provide a boost to institutions seen by the credit rating agencies as top-notch, because the high ratings these banks have actually makes it more difficult for them to structure products as competitively as lesser-rated banks.

A lot of principal-protected notes are structured as a zero-coupon bond plus a derivative, such as a call option for example.

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