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3. Introduction of Structured Note 3.1 Definition
As explained in the Wikipedia7, a structured note is a hybrid security that includes several financial products, typically a stock or bond plus a derivative (e.g. a two-year bond tied together with an option contract). The option contract in addition, changes the security's risk/return profile to make it more tailored to an investor's comfort zone.
The introduction of the structured note provided by The Association of Banks in Singapore for investor‟s knowledge is extracted and provided as below for reference8.
A structured note is an investment with return that link to the performance of one or more reference asset(s) or benchmark(s). These reference assets or benchmarks typically include interest rate, foreign exchange rate, market indices, equities, fixed-income products or any combination of the above. Investor may receive in return, the interest amount and/or principal repayment, which are linked to the performance of the underlying asset(s) or instruments. Investor may receive interest or returns at regular intervals throughout the tenor for some of the notes. The payout may be a specified fixed coupon or subject to an equation described in the terms and conditions of the product.
At the maturity of the structured note, except where there is an early redemption, the investor will receive at maturity, either the whole original principal amount invested or an
7 Structured Note ( visited 30 May 2011) < http://en.wikipedia.org/wiki/Structured_note>
8 MAS Monetary Authority of Singapore. The Association of Banks in Singapore Making Sense of Structured Notes ( last modified 11/2/2010) pg1,3&4
<http://www.moneysense.gov.sg/resource/publications/guides_publications/MakingSENSEStructuredNotes.p df>
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amount calculated based upon the formula stipulated in the product term sheet.
If the issuer of the note has the right to redeem or “call” the notes before the maturity date, the structured note is “callable” at issuer‟s discretion, and investor would normally be redeemed at the full value of the original investment amount for such note.
Examples (types) of structured note:
- Credit-linked Note:
The interest amount and/or principal repayment are linked to the creditworthiness of an entity or portfolio of entities and /or market value of the debt obligations (e.g. loans, bonds etc.) of such entity or portfolio of entities
- Equity Linked Note:
They are Notes that linked to equity indices, e.g. S&P 500, Strait Times Index (STI), or share price of a company, or to a basket of shares or basket of stock indices. Investor may receive shares instead of cash at the time principal is to be repaid.
Structured Notes may also structured to link with foreign exchange rate, interest rate (e.g.
London Interbank Offered Rate (LIBOR)), commodities prices and other asset classes. And sometimes, there are notes with returns that are linked to two or more reference assets or benchmarks, for instance interest or principal return depending on both creditworthiness and share price of a group of companies etc.
Structured notes are typically embedded with derivatives instrument such as options or swap contracts. The issuer of the structure note may enter into a derivative contract with
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another institution in some structures. As a result, the performance of a derivative instrument shall have a direct impact on the returns of the structured note. In simple, the performance of the underlying asset or bench mark (e.g. credit, equities and commodities) shall impact the note‟s overall return.
Sometimes, structured note may also be early redeemed in circumstances where there is occurrence of issuer default, i.e. issuer unable to meet payment obligations, or when there is force majeure or extraordinary event occurred, or if on payments are aroused from the product or taxes are imposed on the issuer, or when market value of any collateral falls and is insufficient to secure any or all issuer‟s obligation under the structured note. In consequence, investor may then receive less than the amount they initially invested.
Structured Note may be issued by a financial institution, e.g. a bank or by a special purpose vehicle that has been set up for the purpose of issuing structured note.
Generally, structured note investment involves risks, depending on the structure of the notes, these risks may include risks such as early redemption risks, reinvestment risks, sub effect of underlying risks, interest rate risks, liquidity risks, credit risks, exchange rate risks, event risks, country risks, inflation risks, call risks, settlement risks and minimum return risks etc.
The below table list some commonly seen structured note and risks associated to each type9.
9 MAS Monetary Authority of Singapore. The Association of Banks in Singapore Making Sense of Structured Notes ( last modified 11/2/2010) pg5
<http://www.moneysense.gov.sg/resource/publications/guides_publications/MakingSENSEStructuredNotes.pd f>
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Table 1 Risks Associated to structured notes commonly seen
Type of Structured Note
Description Key Risks Involved
Equity-linked Equity-linked notes may be linked to a single stock, or a basket of stocks.
Equity-linked notes may also be linked to an equity index (for example, the S&P 500) or a basket of indices.
Returns are dependent on the performance of the underlying stock or basket of stocks, or equity index or basket of indices.
You are exposed to the risk that the level of the underlying asset does not move in the direction and/or by an amount you anticipated.
Where the returns are linked to more than one reference asset (e.g. a basket of stocks), the returns will often not be based on the average of the basket.
For example, the formula may may actually increase the risk.
The issuer may also cap returns, or may exercise its right to cap returns if the equity instrument performs far beyond expectations. With returns capped, you bear the risk of foregoing potentially
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Where the structured notes pay you in the form of shares, you may end up buying shares at a price that is higher than their current market price. by which interest rates move.
You are exposed to the risk that interest rates do not move in the direction or by the amount you anticipated. some cases, you may lose all, or substantially all, of your original investment amount.
You will need to be able to assess the likelihood of a credit event occurring to the
specified entities as well as the entities that constitute the underlying collateral.
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In addition, some of the risks that apply generally to structured notes are listed below10. (p.s.
this is not an exhaustive list.)
Table 2 Common key risks apply to structured notes
Key risk What this means What happens then
Redemption Amount
Credit risk of the issuer The issuer's default on a payment due
10 MAS Monetary Authority of Singapore. The Association of Banks in Singapore Making Sense of Structured Notes ( last modified 11 February 2010) at 6-7
<http://www.moneysense.gov.sg/resource/publications/guides_publications/MakingSENSEStructuredNotes.
pdf>
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3.2 Local Governing Laws and Regulations
In according to the Guidelines for Bank Conducting Financial Derivatives Businesses11 Article number 2, it explain that “ the term “ financial derivatives” shall mean for contract values derive from an interest rate, exchange rate, stock price, index, commodity, or other interest, or from a combination thereof as well as Structured Products. The term “structured
11 Directions for Banks Conducting Financial Derivatives Businesses (last Modified 2009.12.31)
< http://law.banking.gov.tw/Eng/FLAW/FLAWDAT01.asp?lsid=FL006459>
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product” as used herein shall mean a combination transaction of fixed-income products and derivatives products sold by a bank to a client as counterparty to the transaction.
Structured Note Products were largely introduced by Banks to its wealth management customer or non-wealth customer starting from year 2005 to 2008 before the broke out of the financial crisis in US. Banks by applying trust license and approval sought from local authorities (i.e. FSC and Central Bank of China (CBC)) will be able to conduct structured notes business with its customers. Normally Bank‟s customer would need to open a trust account with the Banks before they are able to invest mutual fund or structured note products (offshore or internal structured note products) offered (issued) by offshore or in country investment bank, entities or financial institutions12. In general, Bank‟s would need to comply with the Regulations governing Bank Conducting Financial Derivatives Businesses, Regulations for Bank Conducting Wealth Management( or Non-Wealth Management) Business, Operating Rules for Bank Conducting Wealth Management(or Non-Wealth Management) Business, Trust Business Law and Regulation Governing Trust Business In Managing Specified Trust fund( non-discretionary trust)to Invest In offshore Securities13 and its relevant self disciplinary rules when providing offshore structured note product to its customers.
12銀行銷售雷曼兄弟發行之連動債商品，有關投資人權益問答集 (visited 30 May 2011)
<http://www.banking.gov.tw/Layout/main_ch/News_NewsContent.aspx?NewsID=19236&path=2995&Lan guageType=1>
13信託業辦理特定金錢信託投資國外有價證券業務應遵守事項(visited 30 May 2011)
<http://law.banking.gov.tw/Chi/FINT/FINTQRY04.asp?N2=&sdate=&edate=&keyword=%AFS%A9w%A A%F7%BF%FA%ABH%B0U&datatype=etype&typeid=*&page=1&recordNo=7>