Issuance down 60% amid elections, renewed fears over U.S. tax debate, Europe

By Emma Trincal

New York, Nov. 14 - The elections, the Veterans Day weekend and uncertainty contributed to hamper structured products issuance, causing sales to fall by 65% to $158 million from $448 million in the prior week, a substantial decline even for an early month cycle, sources said.

The market saw a sell-off the day after the elections, triggered by renewing fears over the U.S. fiscal debate, but the temporary spike in volatility was short-lived, failing to boost issuance for the week.

On the month to date as of Nov. 10, the picture remained bleak with a volume of $250 million sold, a 60% decline from $613 million priced in the same period of last month, according to data compiled by Prospect News.

Compared to the first week of October, which recorded $504 million in sales, last week also fared poorly, posting a 69% decline.

"The elections played out a lot," a sellsider said.

"The issuers we work with, I would say they delayed the launch of their products. That did push things back."

On the other hand, the aftermath of Hurricane Sandy had less of an impact, he noted.

"The storm, surprisingly, given the disaster and its consequences, seemed to have had a fairly minimal impact for us from a communication standpoint and products standpoint," the sellsider said.

"I guess it happened at a relatively good time for us. It was the end of the month. Everything had cleared."

Post-elections correction

The day after the elections, the market was hit by a sell-off due to investors' anxiety over the fiscal cliff and renewed concerns about Europe. The Dow Jones industrial average fell almost 2.5% on Wednesday, its biggest drop in one year. However, volatility as measured by the VIX index remained below 20, despite a hike on that day.

"We didn't feel much of an impact from the sell-off," the sellsider said. "We didn't really have products out there. We don't have new issues release for December yet."

What has some market participants puzzled is that volatility remained subdued despite the return of fear to the market. The VIX jumped to 19 on Wednesday, its highest level since August, but it failed to cross the 20 threshold, suggesting that investors are still less worried than the headlines would suggest, sources said.

Or perhaps it is still too soon to tell how the return of fiscal cliff and euro zone concerns may influence volume looking forward.

"That surge in volatility may end up having a positive effect overall for November sales," the sellsider said.

"With people seeing the possibility for significant downside risk, they may want to look at structured notes to hedge that risk away."

Meanwhile, sales for the year are down 18% to $30.77 billion from $37.61 billion.

Volatility still low

"Honestly, I'm surprised things are not a bit more shaky," said Tom May, partner at Catley Lakeman Securities.

"I don't really understand why the sentiment is not worse than it is given all the challenges we're now facing. Not only [do] you have the fiscal cliff in the U.S., but the ongoing problem in Europe hasn't been resolved."

Even the largest offerings were small last week compared to other weeks, with only one deal exceeding $20 million in size, according to the data.

Equity indexes prevailed, making for half of the volume and the majority of the largest products at the exception of the top deal, which was tied to a commodities index.

Those equity deals were linked in majority to U.S. benchmarks with also some global exposure to Europe, either directly via the Euro Stoxx 50 index or indirectly based on the MSCI EAFE index.

For the month, leverage products with partial downside protection (with a buffer or barrier) remained the best-selling structure at 36% of the volume followed by leverage notes with no downside protection, representing 15% of the total.

One saving grace is that volatility is not as low for long-term products, said May.

"The VIX is very short-term volatility. Many products are structured around long-dated volatility," he said.

"Long-dated volatility has indeed been falling over the year. It's not really, really low, but it's getting mid-range.

"It's fair to say that in general, if volatility goes down, it makes the coupon worse," he said.

Vol. term structure

Less volatility is beneficial to leveraged deals as it lowers the cost of the call options used for the enhanced participation.

On the other hand, it may not help the structuring of buffers as those are put together through the sale of puts.

May explained why leveraged buffered notes remained possible to price.

"You play the shape of the volatility curve. You can get more from selling the puts than you would expect because volatility is skewed. As long as you get paid more for selling the puts than what it costs you for buying the calls, it makes it a bit easier to add a buffer or a barrier.

"Low volatility is not a bad environment for leverage and it's not bad for leverage with downside protection if you can play the term structure of the volatility curve," he said.

The sellsider also made the distinction between short-term, mid-term and long-term volatility.

"Most people when they think of volatility, they think VIX, which really applies to the cash market.

"But when you work on these two-year and three-year terms, you're not pricing these off the cash market; you're pricing these off the futures market.

"Every time you see a drop in the VIX, it has an impact on the curve. But in contrast, the two, three-year spot on the curve hasn't really declined," he said.

Despite the positive aspects of the low volatility, sources agreed that it also poses a challenge when structurers struggle to offer attractive coupons. Low levels of volatility have often been seen as the culprit for the declining volume this year.

Regular non-callable reverse convertibles for instance made for approximately 10% of the volume last week and this month and only 5% of the market share for the year.

Fear has yet to come

"I'm not too sure what would trigger sales and volatility," said May.

"Perhaps as central banks are printing more and more money, inflation would come in, causing a sell-off and a volatility hike.

"But in the meantime, I think we are on for a market trading sideways for a while, making everything rather boring to trade.

"What is it going to take for volatility to kick out again? I have no idea."

"The market is so much influenced by governments' interventions, it's almost impossible to predict anything. We know that for now, governments are keeping asset prices up. It's very difficult to know what's going to happen," he said.

The fact that regulators are increasingly looking at sales of non-traditional investments to retail investors has not helped the business, the sellsider said.

"There is quite a process for every firm to introduce new products, to get new products to their platform," he said.

"I'm sure that these compliance factors play their part in slowing down volume for everyone. Overall the business in 2012 has been hit to some degree by the higher regulatory scrutiny products have been put under recently. There's always been a regulatory focus on our business, but it seems to have ramped up a little this year and it makes it a little cumbersome for financial advisors to transact in the business.

"Inevitably it has played out with other firms as well. We all have to play by the same rules. If it's tough for one, it's tough for others," the sellsider said.

Top offerings

The top deal was commodities-based and brought to market by Deutsche Bank.

Deutsche Bank AG, London Branch priced $26.5 million of securities due Dec. 19, 2013 linked to the Dow Jones-UBS Commodity Index Total Return.

The notes were putable at anytime and would be called if the index declined by 15% or more.

The payout upon redemption or at maturity was par plus triple the sum of the index return minus the T-Bill return minus an adjustment factor. Interest equaled one-month Libor minus 16 basis points and was payable monthly.

Royal Bank of Canada priced the second largest offering with $16.87 million of 0% buffered enhanced participation equity securities due Jan. 23, 2015 linked to the S&P 500 index. The structure offered a 200% participation rate on the upside with a 22% cap. There was a 10% buffer on the downside with a 1.1111% downside leverage factor applied for each 1% decline beyond the buffer.

Royal Bank of Canada was the top agent for the week with 11 deals totaling $37 million, or 23.80% of the total. It sold two out of the five top offerings. Its retail distribution arm, RBC Capital Markets LLC, sold all 11 RBC-issued deals.

"RBC had a good month in October and they probably had their best week last week," a source said. "It could be the market uncertainty, the elections, the fiscal issue. People are positioning themselves trying to protect some of their investments."

UBS was the No. 2 agent followed by Deutsche Bank.

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