The 10 structures to look out for in 2010

Structured notes were on the canvas after Lehman Brothers’ collapse destroyed investor confidence and the market’s biggest counterparty. However, the market has made a remarkable return. Francesca Young looks at what are set to be the most popular structures in 2010.

  • 13 Jan 2010
Email a colleague
Request a PDF

Just a year ago, the structured note market looked all but dead after the collapse of Lehman Brothers, a swap counterparty for exotic trades, left issuers with exposure to swaps that were difficult or expensive to rehedge.

The collapse also knocked the confidence of investors, many of whom had bought structured notes using Lehman as issuer, assuming there was no credit risk to worry about.

Structured note issuance in 2009 was light and restricted to easily rehedgeable deals. But it grew stronger as confidence in banks returned and yields on vanilla notes — the alternative to structured products — tightened sharply across all sectors.

Investors, are again looking at ways of picking up higher yields in a low interest rate environment and at tailored products to hedge their portfolios. The landscape looks set to change as the structured note market returns in earnest. Here are EuroWeek’s top 10 structures for 2010.

1.Volatility bonds

These are linked to the absolute change in some underlying, usually interest rates, so whether the prices of bonds go up or down, the holder can still make a profit.

"If you have a big move in the underlying reference rate, that’s when you’ll get a big coupon," says Toby Croasdell, vice president of MTNs and structured notes at Barclays Capital. "Institutional clients, and in particular insurers, like these because it’s exactly during those times of market volatility that the returns of your fixed income portfolio are hurt."

Volatility bonds also serve as a diversification tool in a portfolio of stocks as equity weakness is associated with high interest rate volatility.

Hedge funds are big players in the volatility market and use it to hedge risk as well as to earn profits by taking views on the course of volatility.

"With short end rates at stable lows with few signs of increasing in the short term and volatility still at high levels, investors can seek to take advantage by buying notes that play the expected movement in rates against the actual movement," says Paul Jones, an MTN dealer at UBS.

Pricing of these notes is contingent on the expected level of volatility, which is lower than a year ago but still higher than the historical average. These notes are likely to be more prominent in 2010.

2. Callable Range Accruals

Regarded as the simplest of structured notes, range accruals are popular every year but achieved fame last year as a survivor.

They are most commonly sold in $5m-$50m clips, usually as a retail product to private banking clients.

"Their flexibility adds to their populartity. They work for any underlying or dual underlying: FX, Libor, BBSW and CMS are just a few that we saw last year," says Jones at UBS.

The bonds typically include non-call periods of only three or six months and for this reason, financial institutions rather than sovereigns, supranationals and agencies tend to issue them — SSAs are unwilling to take funding that short.

3. Constant maturity swaps (CMS) notes

Last year was a strong year for CMS notes, although many were done in Schuldschein format. Demand for the notes, which are most commonly principal-protected, is expected to continue in 2010.

In a CMS swap one of the legs pays a swap rate of a fixed maturity, while the other receives a predetermined fixed or floating rate.

CMS swaps allow hedging of long-dated positions, so investors such as life insurers are frequent buyers — insurance policies need to be hedged against the sharp rise of the back end of the interest rate curve.

But other institutional investors have heavily invested in the CMS market to enjoy yield enhancement and diversified funding. In a steep curve environment, swaps paying CMS look attractive to clients that think the swap rates would not go as high as the market is pricing. Alternatively, in a flat yield curve environment, swaps receiving CMS look attractive to those thinking that swap rates would rise as a consequence of the steepening of the curve.

4. Callable zeros and callable fixed and floating

The callable zero structure was popular throughout 2009 but activity died down after the summer as yields tightened to the point that they no longer hit the yield targets of Asian investors. Typical sizes for callable zeros are between $10m-$50m.

Five Taiwanese insurance companies authorised to buy only vanilla products bought around 80% of callable zeros. In Taiwan, callable zeros are considered vanilla. The insurance firms want notes with long durations and callable zeros give higher yields compared with SSA vanilla products.

As interest rates decline, so do the yields on callable zeros. SSA issuers hit yield targets last year but in 2010 investors will be forced to move down the credit curve, taking notes issued by financial institutions, say dealers.

"There’s very strong demand for this structure in dollars sold into Asia, and only a little for euros from European investors," says Jones at UBS.

Callable fixed and floating rate notes will also return. The pick-up offered in a short dated callable trade compared to a bullet last year did not offer a good enough return for investors, but this is likely to change.

"The pick-up between the coupon of callable fixed rate trade compared to the coupon of a similar bullet decreases in a steep curve environment. The steep curve reduces the likelihood of exercising the call option as this implies dealers should benefit more from higher forward rates in the future," says Bob Jones, a structured note analyst at Barclays Capital in London.

5. FX basket notes

As governments wrestle with economic recovery and budget deficits, their relative successes will be played out in FX markets.

"We expect investors taking a view on the relative strengths of different economies to do this through structured notes by going long and short the respective currencies in a basket," says Jones at UBS.

Using a basket of currencies rather than a single currency will take advantage of correlation risk, while achieving a higher return. However, the currencies involved will be non-exotic, mostly BRIC currencies.

The demand will mostly be for principal-protected bonds, but with light demand for principal and coupon-linked notes, says Jones. Typical buyers are European retail investors.

6. Inflation-linked notes

Inflation is a prime worry for investors. Its threat looms large after the recent monetary stimulus and government spending. Inflation-linked bonds can hedge this risk.

Demand for this structure rose in the fourth quarter but as inflation-linked notes are difficult to hedge, it was difficult to find issuers.

"Inflation-linked-notes are difficult to value and hedge and a lot of issuers are unwilling to take the risk of having to re-hedge the exposure should there be another Lehman-style problem," says one MTN dealer.

In 2009, the sporadic inflation-linked note issuance was all linked to liquid inflation indices, such as the HIPCC, because these notes would be simple to rehedge. But the demand for more bespoke indices is there.

"People are always going to want to look at bespoke country indices provided that they can obtain the hedge," said Croasdell. "We’ve done Norwegian inflation notes for example. But clearly people are predominantly interested in the core ones like the UK, Europe, US."


Investors increasingly want the security of UCITS (Undertakings for Collective Investments in Transferable Securities) III funds, with the bankruptcy-remoteness and independent valuation they provide, through the use of independent, third party custodians and segregation of assets.

Investors will be attracted to the liquidity and transparency in such UCITS III structures as they are unwilling to take the credit risk of structured product issuers or are precluded from such credit risk, due to external or internal regulations.

Target sizes for UCITS III funds range from $100m to $500m.

"UCITS III funds are already attracting very strong interest from global investor types from retail clients to institutions — insurance companies, pension funds, asset managers, sovereign wealth funds etc," says a structurer.

8. Equity-linked notes

Demand for the principal-protected equity-linked structure will grow in the improving economic environment, strengthening equity markets and high underlying volatility.

"The Uridashi market has been active in one year notes of this type in yen, but there is also a European market out to five years," says Jones at UBS, adding that Italian investors are especially active in these notes.

Alpha-generating structures — that is, principal and coupon-linked structures aiming to outperform equity markets — may also be popular.

Optimised beta structures are also tipped — optimised market timing through the use of quantitative signals to determine to what extent the structure should have exposure to the underlying equity market.

9. Structures linked to new underlyings

Structures linked to innovative and bespoke underlyings may be in demand, say structurers, provided that the bonds can be self-led, to avoid rehedging risk, and can be issued by entities collateralised to reduce issuer risk as only financial institutions will have the capability to manage these bonds.

Underlyings include global equity indices whose exposure to each region varies according to predetermined criteria, for example, or indices providing exposure to emerging or strengthening global trends, such as new energy and changing demographics or global longevity.

10. Collared FRNs

Floating structures in 2009 were defensive, with floors common and even ratchet floor floaters — highly structured notes, but fitting in with investor risk adversity.

The notes were placed in response to heavy demand from investors seeking protection from the risk of falling Libor rates. But as risk-taking returns and yields tighten, caps may be added and floors may even be removed.

"You don’t want to be locked into a fixed rate for any significant duration," says Bob Jones at Barclays. "If you can have a note that will allow you to participate in an increase in rates while giving you attractive pick up today, that’s interesting."

"We’re probably going to see the move to fixed caps first and then ratchet caps," said Croasdell. "It’s an older structure, but will be one of the first things to come back in a rate hiking environment."
  • 13 Jan 2010

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 71,795.24 248 8.65%
2 JPMorgan 59,685.75 255 7.19%
3 Bank of America Merrill Lynch 52,401.35 173 6.31%
4 Barclays 50,153.02 148 6.04%
5 Deutsche Bank 44,937.03 167 5.41%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Deutsche Bank 9,857.42 14 13.05%
2 SG Corporate & Investment Banking 7,833.35 12 10.37%
3 Goldman Sachs 5,773.27 11 7.65%
4 Citi 4,606.54 14 6.10%
5 BNP Paribas 4,132.76 19 5.47%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Goldman Sachs 2,546.04 12 11.21%
2 JPMorgan 1,732.54 10 7.63%
3 Credit Suisse 1,727.84 7 7.61%
4 Deutsche Bank 1,465.10 11 6.45%
5 Citi 1,285.41 7 5.66%