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Merrill Launches First China CPPI Structure

Merrill Lynch recently launched what is believed to be the first principal protected structure on Chinese shares structured with a threshold guarantee rather than options. John Robson, managing director and head of structured products in the global equity markets group in Hong Kong, said Merrill has offered capital guaranteed notes on mainland China shares that incorporate the traditional bond plus option structure, but opted for a constant proportion portfolio insurance (CPPI) structure because the global sell off in bonds and falling equity volatility meant it is now more attractive.

The U.S. house privately placed USD90 million of notes, dubbed China Direct Access, in Asia, Europe and Latin America. "More and more investors are beginning to learn the China story and are looking to get involved," said John Robson, managing director and head of structured products in the global equity markets group in Hong Kong.

The notes track the performance of the firm's China Dragon Index, which is not only made up of mainland names but also companies from Hong Kong, Taiwan and Singapore which have at least 25% of their revenue or assets in China. Using the CPPI methodology, a portion of the principal investment is shifted out of the index and into U.S. government bonds if the China Dragon index falls by 6-7% and every 5% thereafter. Conversely, if the index shoots up in value, hitting trigger points at 120% and every following 20%, half of the gains are locked in. Initially, the China Direct Access notes are fully invested in equity.

The maturity of the structure is 10 years, but there is daily liquidity. "We're treating this more as a stock or managed fund than a principal protected product," he added. Robson continued that Merrill is also planning to offer the product to Canadian investors by year-end, adding that the product will not be available in the U.S. in its current form since it contains some shares listed on exchanges that are not recognized by U.S. regulators.

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