Derivatives shops are increasingly trading gap risk notes, which pay investors a spread over LIBOR in return for a one-off payment if the equity market crashes. The dealers have kick started the market because they need prices in order to book profit under International Accounting Standard 39, and the trades also provide protection to derivatives houses that sell capital-protected fund products (DW, 7/18).
IAS 39 means banks have to mark derivatives sales to market and can only recognize upfront profit on sales that have a readily available market value, explained John Hitchins, U.K. banking leader at PricewaterhouseCoopers in London.
Structurers said gap notes sold to hedge funds and OTC trades between dealers are becoming more popular as a way of solving the accounting problem. "But what we need is a market for gap risk on something like the Standard & Poor's hedge fund index," noted one dealer.
One marketer said he thinks the difficulty of pricing gap protection for accounting purposes has limited the volume of CPPI products issued by some houses. "Certainly there are banks that are doing less CPPI than they used to," he noted, but declined to comment on which houses had been affected.
