Deutsche Bank’s leveraged notes linked to CAC 40 index use an index consigned to oblivion

By Emma Trincal

New York, Feb. 2 – Deutsche Bank was set to price on Friday notes linked to one of the less remarkable if not most unloved underlying among European countries: the benchmark for the French large-cap stock market.

Deutsche Bank AG, London Branch announced it will price 0% knock-out notes due Aug. 7, 2019 linked to the CAC 40 index, in a 424B2 filing with the Securities and Exchange Commission.

The CAC 40 is a free float market capitalization weighted index that reflects the performance of the 40 largest and most actively traded shares listed on Euronext Paris.

The index serves as an underlying for structured products, funds, exchange traded funds, options and futures, according to the Euronext website.

Yet it has been left out of the U.S. structured notes market, as evidenced by data compiled by Prospect News.

Near zero volume

Since June 2005 when Prospect News began collecting data on equity index-linked notes, only one small deal linked to the CAC 40 has been priced, based on Prospect News data, which keeps track of all U.S.-registered notes.

The deal – a $500,000 offering of digital notes – was issued in August by Royal Bank of Canada and distributed by JPMorgan.

The CAC 40 index has been employed many times in baskets along with other international equity benchmarks. But as far as linking a note to this index alone, that’s all there has ever been, according to the data.

“In my years and years – I won’t say how many... of working in the structured products industry the CAC 40 has always been one of the rarely used references compared to U.S, Japan, Europe or the U.K.,” said a New Yok-based structurer.

Most advisers though would have no difficulty presenting the index to their clients as some of its components are stocks of highly visible multinational companies such as Airbus, BNP Paribas, Danone, LVMH, Peugeot, Sanofi, Total and Societe Generale.

Loving diversification

But U.S. investors are not particularly keen on making country-specific bets in general, including in Europe, sources said.

The appetite for this regional market however is strong as a whole as long as the underlying is a broad index. The Euro Stoxx 50 index for instance is the second largest equity index underlier after the S&P 500. Since June 2005, $25 billion of notes linked to the Euro Stoxx 50 index have been sold in the United States while $92 billion came out from the S&P 500 index, the data showed.

“If you’re a U.S. investor and want to play the euro zone, you play the Euro Stoxx 50. That’s the most straightforward thing to do,” said a structurer based in Europe.

European country-specific indexes are commonly played but in the form of baskets.

Northerners

Four countries, however, seem to be the exception and have been reasonably successful at attracting investors in the structured products space.

The top one is Germany. Its DAX index has been employed for the issuance of $390 million of structured notes brought to market in 45 deals since June 2005.

Often time, notes are linked to the price return of the German benchmark as the DAX is a total return index, explained the European structurer.

“The dividends are being reinvested in the index. Using the total return will push up the forward. With less chances of breaching the barrier your coupon would be lower. It’s not that appealing.”

Coming next is the U.K. with 37 offerings amounting to $181 million linked to the FTSE 100 index during that stretch.

Southerners

Going down to Southern Europe on the map, demand is lower. Still those countries fare much better than France.

Bets on Italy have been behind $20 million of notes linked to the FTSE MIB index in three deals since June 2005.

Spain accounts for four deals on the IBEX 35 index for a $14.1 million notional.

Separately $15 million have been priced on the MSCI Spain 25/50 index. In addition, notes linked to the same stocks as the components of the MSCI Spain 25/50 index but organized in a basket with different weightings have also been relatively popular with $43 million.

“Our bank nine months ago was bullish on Spain. Companies had good prospects in earnings...The unemployment was going down. The index was also more volatile. It made sense to structure notes on it,” the European structurer said.

Unproven hypotheses

He did not see any pricing issues as a potential explanation for the lagging volume of notes linked to French stocks.

“As long as you have liquidity, futures you can hedge on, you have no problem. The CAC 40 is perfectly liquid. There are no issues there,” he said.

“It’s more of a macroeconomic factor,” he said.

Germany is often perceived as Europe’s engine of growth. The U.K. despite Brexit has a strong economy. Countries such as Italy and Spain have a turnaround story to tell. But there is no such thing around France, he explained.

“American investors and managers don’t have such a great view on France.”

Another possibility would be the license cost of the index, he said.

“You can pay a high lump sum or pay the license per product as you go. I don’t know anything about the cost of licensing the CAC but perhaps the license agreement with the sponsor is pricey, not sure.”

CAC 40 is a registered trademark of Euronext NV, which is the sponsor of the index.

A bit of a mystery

The New York structurer said there was no other explanation than investors’ view on the French markets.

“I think it’s mostly because of comparatively limited interest in the underlying rather than technical difficulty to price,” he said.

Yet compared to the four other European countries the French benchmark has outperformed over the past year, gaining 26% ahead of the FTSE 100, up 20%. Germany was at the bottom with a 3.5% gain. The CAC also is the second-best performer after the German market for the last five years with a 42% positive return versus 63% for the DAX.

The New York structurer said the weak volume shown in the data came as a surprise.

“Why is there no appetite for the French index? That’s a good question. I don’t see why CAC 40 is left out if investors do Italy or Spain. Very curious....”

The Deutsche Bank notes offer 1.46 times upside leveraged exposure with no cap. A 75% barrier offers contingent protection on a point to point basis for the downside. JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the agents.

The deal will settle on Wednesday.

The Cusip number is 25155MJD4.

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