Citigroup’s 14-month buffer securities linked to FTSE 100 may turn volatile amid Brexit talks

By Emma Trincal

New York, July 3 – Citigroup Global Markets Holdings Inc.’s 0% buffer securities due Aug. 30, 2018 linked to the FTSE 100 index offer relatively good terms, advisers said. But the timing – just as negotiations have started about the United Kingdom’s exit from the European Union – is sure to add volatility.

The FTSE 100 is the U.K. large-cap benchmark consisting of the 100 largest companies listed on the London Stock Exchange.

If the index return is positive, the payout at maturity will be par plus 125% of the index gain, subject to a maximum return of 13.15%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will lose 1% for every 1% that the index declines beyond the 10% buffer.

“The thing that would concern me the most about this deal obviously is the process of Brexit going on and the implications for the market,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

His view on the terms of the product was mixed.

“I do like the short maturity,” he said.

“I don’t know that the leverage is all that attractive.

“You’re getting a good buffer for that, which is fine, although this level of protection might not be enough.”

Unpredictable

A year ago, the United Kingdom voted to withdraw from the European Union. Theresa May, the leader of the Conservative Party, was then appointed prime minister. Earlier this month, May’s party lost its majority during a general election at a time when the Brexit negotiation with the E.U. members was just beginning.

“Given that it’s not clear what’s going to happen politically, it’s hard to know the risk/reward of this note,” Chisholm said.

“There are a lot of unknowns that are too important to make any sort of analysis that we don’t know.

“In my mind, it’s more of a gamble because of that.”

Difficulties ahead

Chisholm said that the European Union does not want to “encourage” another country to exit the European Union.

“They’re going to treat the U.K. harshly, which means that it’s unlikely the negotiations will go smoothly,” he said.

“With an antagonistic negotiation, a lot of things could go wrong.”

Many of the discussions will tackle complex topics, such as budget, banking, trade and the Schengen open-border agreement.

Chisholm said it will take some time before an agreement is reached. In the meantime, more volatility is expected.

“The index could drop 10%, or it could drop a lot more,” he said.

“I just wouldn’t be looking at that market at all. There are too many unknowns to make a well-informed decision.”

Quanto

Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, said that the product is designed to navigate a slight increase in volatility but not extreme price moves.

Noting that the notes give U.S. investors access to foreign stocks, his first comment was about the benefit of having no exposure to currency risk.

This means that the underlying index performance is not adjusted for changes in the exchange rate, as stated in the prospectus. The feature, called “quanto,” is standard in most structured notes linked to non-U.S. stocks.

“You get a pure equity exposure with no currency risk, which is interesting,” he said.

As a result, investors will not be able to benefit from a weakening of the dollar against the pound. But by the same token, the opposite scenario will not cause any losses.

“This gives you a hedge compared to an ETF. If you want a pure exposure to the U.K. market, that’s very attractive,” he said.

Short is sweet

Tiemann said he also liked the 14-month duration.

The short maturity lessens credit risk exposure and reduces the opportunity cost associated with the non-payment of dividends.

The FTSE 100 pays a dividend of 3.52%. Over 14 months, investors lose 4.10% in yield.

“It’s a fat yield, but it’s only a little bit over a year. Better lose one year worth of dividends than five,” he said.

Downside protection

Tiemann also believes that the U.K. market can see some turmoil in the upcoming months due to the Brexit negotiations.

“It looks like the notes are designed for that. You’re selling volatility in this thing. The upside and the downside are both chopped off with some leverage in the middle,” he said.

The 13.15% cap is enticing in this uncertain market, he noted.

“The Brexit negotiations could bring a very positive outcome just like it could generate a very ugly outcome. We just don’t know,” he said.

“The notes are designed to give you a little less of the extremes and set you more in the middle.

“You’re sacrificing the upside for the sake of having some downside protection.

“Given the uncertainty it may be a good time for having that posture.”

Stronger pro-Europe camp

The Brexit negotiations have just taken a new turn with the last elections, he said, pointing to what he sees as a setback for the pro-Brexit party.

“There are a few surprises. After the French elections, at this stage the Europeans have stronger players at the table of negotiation.

“Merkel herself looks much stronger than six months ago.”

He was referring to Angela Merkel, Germany’s chancellor. The other “stronger player” is Emmanuel Macron, who won the presidential elections in France in May.

The pro-Europe side of the negotiations, with its two partners France and Germany, may now have the upper hand, he reasoned.

But this factor will not necessarily resolve all problems, especially in the short term.

“The U.K. will still have to manage an uncertain environment.”

Uncommon underlying

The FTSE 100, also known as the Financial Times Stock Exchange 100 index, is rarely used as an underlying index in structured notes, data compiled by Prospect News showed.

For instance during the first half of this year, this index was used as sole underlier only once: in a small leveraged buffered deal that Barclays Bank plc priced in January for $365,000.

Despite the Brexit referendum looming at the end of last year’s first half, no deal linked to the FTSE 100 as a standalone underlier was priced during that time.

Instead, the FTSE 100 has been used in association with other international benchmarks either in worst-of notes or as a basket component, the data showed.

Citigroup Global Markets Inc. is the agent.

The notes are guaranteed by Citigroup Inc.

The notes settled on Friday.

The Cusip number is 17324CK96.

© 2015 Prospect News.
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