Germany’s biggest bank sold so-called reverse convertibles at prices furthest from their fair value, said Simon Ullrich, managing director for Scope’s derivatives business in Berlin. The securities suffer losses when a stock or index falls below a pre-defined level and the Deutsche Bank notes were on average 0.8 percent above fair value, compared with zero percent with other issuers, he said.
Buyers of structured notes typically pay above the fair value price to cover expenses associated with underwriting, distributing and marketing the securities. The U.S. Securities and Exchange Commission is pushing issuers to disclose the notes’ estimated initial value, while European regulators are also considering similar measures to improve transparency.
“If you know the fair value of a note then you have the option to shop around,” said Ullrich. “You don’t need to buy from Deutsche Bank, for example, when you could get a very similar trade with a similar risk profile for a better price at Vontobel.”
Sebastian Howell, a spokesman for Frankfurt-based Deutsche Bank in London, declined to comment on Scope’s research.
Scope analyzed about 100 notes linked to the performance of the Euro Stoxx 50 Index (SX5E) that were traded on Stuttgart-based exchange Euwax from April 1 to April 15. It calculated their fair value several times a day mainly by monitoring movements in credit-default swaps for the issuers, a measure of creditworthiness, and the implied volatility of options on the Euro Stoxx 50 index.
Stuttgart-based Landesbank Baden-Wuerttemberg and Zurich- based Vontobel Holding AG (VONN) offered the best prices, with an average deviation from fair value of zero, Scope said. The ratings company also analyzed notes issued by Commerzbank AG (CBK), DZ Bank AG, HSBC Holdings Plc, Royal Bank of Scotland Group Plc (RBS) and UBS AG.
Scope was founded in 2002 and employs more than 70 people in Berlin, Frankfurt, Stuttgart, Amsterdam and Luxembourg, according to its website. The ratings firm is seeking to challenge Standard & Poor’s, Moody’s Investors Service and Fitch Ratings as it expands its coverage into European and global banks.
Wolfgang Gerhardt, head of Vontobel’s German financial products business, said fair pricing has helped the banks remain among the top four issuers of structured notes. LBBW also aims to offer fair value to investors in reverse convertibles, said Fabian Blumer, retail product manager at the bank.
LBBW was the second-largest issuer of reverse convertibles in March, selling 23.2 million euros ($30.3 million), according to Euwax. Vontobel was the fourth-biggest issuer in the month, with 17.6 million euros of sales while Deutsche Bank was the biggest seller, offering 31.2 million euros of notes, Euwax data shows.
Scope also analyzed quote sizes, an important measure of liquidity, according to Ullrich. He says larger sizes allow investors seeking bigger trades to avoid being charged repeatedly for making multiple smaller trades. Vontobel offered investors the largest size of note at 500,000 euros, according to the ratings firm.
Scope’s research showed RBS had the tightest bid-ask spread for reverse convertibles at 0.05 percent, while Deutsche Bank had the widest at 0.2 percent.
Investors in the German market are holding about 5 billion euros of outstanding reverse convertibles, according to Deutscher Derivate Verband, the country’s derivatives association.
Structured notes package debt with derivatives to offer customized bets to investors while earning fees and raising money. Derivatives are contracts whose value is based on stocks, bonds, currencies and commodities.
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