U.S. issuers of structured notes are examining starting an interbank market in structured notes to get around an accounting change that prevents them from taking up-front profit on the instruments.
The rule change means derivatives houses subject to U.S. GAAP have to amortize profit on all notes structured with embedded derivatives. This will impact any issuers of equity-linked and credit-linked notes, the largest of which include Deutsche Bank, Citibank and JPMorgan. Officials at the banks declined comment.
In an interbank market, banks would buy a note from another sellside firm and then sell it to a buysider. This would avoid having to structure the note and amortize the profit. Because a bank entering such a transaction would no longer have any risk, it would be able to book all the profit from placing the note. This market would likely be limited to plain-vanilla notes, in which most of the profit comes from the placement rather than the structuring.
One problem, however, is the Securities and Exchange Commission may consider this 'roundtrip' trading. "It may look perfectly respectable, but if it is to circumvent an SEC announcement this is bad news from a reputational point of view," explained a derivatives lawyer. He added that several banks, including Merrill Lynch and JPMorgan, were rapped over the knuckles for certain trades with Enron and would review any instruments designed for accounting reasons with a fine-tooth comb.
One derivatives professional stressed that the banks would be taking real risk in the trades and it would function in the same way as any other market, and therefore, would not constitute 'round trip' trades.
