HVB Group plans to launch what is thought to be the first retail credit-linked equity certificate. The German bank will offer investors an enhanced return to a basket of stocks by selling embedded credit-default swaps on the same names. Vassilios Pappas, head of global derivatives at HVB in Munich, explained investors in the structure would likely be happy to sell default protection on the name because in buying the stock they are showing they like the company. In addition, the structure will be capital protected, noted Pappas.
A number of derivatives houses have combined credit and equity structuring teams in recent months in order to focus on hybrid products, but none, according to a straw poll by DW, have tapped retail investors with an offering. This is partly because most houses see the business as institutional, because of the difficulty in getting regulators to sign off on retail products with credit components. Officials at rival houses said HVB may struggle to get the products past some regulators, particularly in Italy, where credit products have lost favor in the last year because of the Parmalat debacle (DW, 4/25).
Rival derivatives structurers also said the instrument will be difficult to hedge because the correlation between credit and equity changes. Pappas said it has taken over a year to come up with an efficient credit equity hedging model, but he is now satisfied the firm can hedge the instrument.
HVB combined its trading and marketing forces in both asset classes a year ago and has since issued several hybrid instruments. These have previously involved equity combined with interest rates, foreign exchange or commodities because the correlation between the underlying is more stable, according to Pappas. The asset classes also have the advantage of being established with more extensive data and robust models.