Structured Note Sales Drop 73% on Disclosure Rules: India Credit

Structured note sales in India dropped at more than twice the global pace in the first half after issuers balked at new regulations aimed at limiting risk and investors avoided securities linked to falling stocks.

Offerings declined 73 percent to 5.88 billion rupees ($106 million) from the first half last year, the lowest in at least two years, according to the most recent figures from the Securities and Exchange Board of India. Worldwide sales of the notes, which offer customized bets linked to stocks, currencies, commodities and interest rates, fell 31 percent to $61.8 billion in the same period, according to data compiled by Bloomberg.

“Issuance has slowed down because issuers were grappling with the new requirements,” said Rajesh Iyer, Mumbai-based head of products and research at Kotak Wealth Management, which provides financial advice for 30 percent of India’s 100 richest families, according to its website. “Private banks and intermediaries that have budgeted for structured notes will feel the pressure.” Sales were “slightly better” in July and August, he said.

India introduced rules for structured notes in November, joining regulators globally in increasing scrutiny of complex investments after billions of dollars of losses from derivatives trading during the financial crisis. With more than 90 percent of the securities in India linked to equities, wealthy people who are the biggest buyers of the products also shunned the market after the benchmark BSE India Sensitive Index of stocks slipped 16 percent from its peak in 2010.

‘Challenging’ Phase

The Securities and Exchange Board of India on Nov. 1 began requiring sellers to publish daily valuations of the notes through independent agencies and make investors aware that their bets may not be hedged and the principal not always protected.

Issuers including the Indian units of Morgan Stanley (MS), Credit Suisse Group AG, Bank of America Merrill Lynch’s Indian unit, Macquarie Group Ltd. and Nomura Holdings Inc. have published valuations that are available on the website of Crisil Ltd., which handles about 95 percent of structured-note valuations.

“The initial phase was quite challenging as no agency had the wherewithal to value these structures,” and issuers spent several months working out models, said Prateek Pant, director, products & services in Mumbai at RBS Private Banking. “There’s been a significant break in the momentum in the structured product market.”

Worst Markets

The new regulations have added to a slowdown in the market as investors in Asia’s third-largest economy shun riskier assets as the Sensex (SENSEX), as well as the broader S&P CNX Nifty Index, struggle to recoup losses after they both plunged 25 percent last year, the worst performances among the world’s biggest markets.

It may be in the interest of investors to keep non- principal protected products “out of reach of all but the most sophisticated investors,” N. Hariharan, a spokesman at the market regulator, said in an e-mailed response. “The number of issuance and outstanding value of structured notes has gone down on account of stringent regulatory requirements.”

As much as 95 percent of the structured notes sold in India are linked to equities, according to Amit Gupta, director of institutional sales at Barclays Capital in Mumbai.

“Because the equity market in the last two to four years hasn’t done very well, investor appetite for equity-linked structured notes has come down quite drastically,” said Amitabh Mohanty, head of fixed income at Reliance Capital Ltd. (RCAPT) High net- worth individuals, who typically have $1 million or more of investable assets, buy at least 60 percent of India’s structured notes, according to Mohanty.

Wealthy Clients

The number of millionaire households in India rose to 162,000 last year from 134,000 in 2010, the sixth-highest in Asia, according to The Boston Consulting Group’s 2012 Global Wealth report. The country also has 278 households with more than $100 million, or ultra-high net-worth individuals, up from 241 in 2010, according to the report.

The nation’s individual wealth may triple in the five years from 2011 with growing interest in more complex investment schemes to boost returns, according to estimates from Karvy Private Wealth, an adviser to high net-worth clients in India.

“There is certainly a lot of latent demand for structured products from mostly high net-worth clients,” said RBS’s Pant. The products in India can offer investors as much as 350 basis points more than bonds, he said.

Corporate Bonds

Elsewhere in the markets, the yield on India’s 8.15 percent government bond due in June 2022 rose one basis point to 8.15 percent in Mumbai, according to the central bank’s trading system. The yield on the benchmark 10-year sovereign bonds has fallen about 42 basis points this year.

The extra yield on India’s 10-year government bonds over similar-maturity U.S. Treasuries widened five basis points to 650, according to data compiled by Bloomberg.

Ten-year borrowing costs for companies rated AAA by Crisil, the Indian unit of Standard & Poor’s, rose one basis point to 9.49 percent on Aug. 8. Yields have increased from 9.42 percent at the start of the year.

The Sensex fell 0.15 percent to 17,534.72, as the Nifty declined 0.13 percent to 5,315.95. The rupee weakened 0.1 percent to 55.3550 against the dollar.

Credit-default swaps on State Bank of India, which some investors consider a proxy for the sovereign, fell one basis point to 311 in New York, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

‘Cautious Attitude’

India introduced the new rules three years after Lehman Brothers Holdings Inc.’s collapse caused multi-billion dollar losses globally.

Citigroup Inc. (C)’s Indian unit has begun compensating investors after an employee in its wealth-management division allegedly defrauded them of 3 billion rupees invested over 15 months, the U.S. bank said in January 2011.

“There is an overhang of losses in investors’ minds from aggressively sold relatively exotic structured products during the bull-run up to 2007,” Swapnil Pawar, chief investment officer at Karvy, said in e-mailed comments. “The attitude of regulators is cautious.”

The U.S. Securities and Exchange Commission is asking banks that issue structured notes to boost disclosures to investors, according to a letter posted on its website in April. Some U.K. banks are also withdrawing commission payments to independent financial advisers that are typically included on the products in advance of new regulations that will affect how advisers make and disclose charges.

“Investor protection has strengthened in the minds of regulators because of global market conditions and events in the industry,” said Shiv Gupta, managing director at RBS Private Banking, India. “Uncertainty over making investments in this environment has affected many clients.”

To contact the reporters on this story: Jun Yang in Seoul at jyang180@bloomberg.net; Ruth David in Mumbai at rdavid9@bloomberg.net

To contact the editor responsible for this story: Shelley Smith at ssmith118@bloomberg.net

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