How Lehman-linked Minibond, High Note, Jubilee Structured Note work
Many investors and non-investors alike, including me, have been baffled by the complexity of the Lehman-linked structured notes. I will attempt to shed some light on the inner workings based on what I managed to figure out. Most of the information found here are from the Lehman Minibond Base Prospectus and Minibond Series 2 Pricing Statement. The following are my own understanding and is for information only and not an exhaustive and official explanation. Some of the affected structured products may work in a different way.
Parties Involved
- Note-holders - The investor. Yes, that’s you
- Issuer – A company set up by the Arranger (a subsidiary of the financial institution) to issue the note
- Swap Counterparty – A subsidiary of the financial institution that goes into a Swap Agreement on promises to fulfill some obligations agreed according to the Swap Agreement
- Reference Entities - A list of reputable companies whose credit risk the note-holders are exposed to
- Underlying Securities – A basket of securities to back the Reference Entities. Some of the Structured Notes utilise credit-linked notes or synthetic Collateralized Debt Obligations (CDO) as the Underlying Securities. Note-holders are also exposed to the credit risk of the Underlying Securities
How The Notes Work
At Issuance of Note
What is a Credit Event?
Credit Event is the ‘Bankruptcy’, ‘Failing to pay’ or ‘Restructing’ of the Reference Entities. As there is a ‘First-To-Default’ clause, as long as any 1 of the Reference Entity were to fulfill any of the above criteria. A Credit Event is said to have occurred.
Credit Event is the ‘Bankruptcy’, ‘Failing to pay’ or ‘Restructing’ of the Reference Entities. As there is a ‘First-To-Default’ clause, as long as any 1 of the Reference Entity were to fulfill any of the above criteria. A Credit Event is said to have occurred.
Other than being exposed to the credit risk of the Reference Entities, the note-holder is also exposed to the credit risk of the Underlying Securities. The Underlying Securities has similar credit event definitions to the Reference Entities. If a Underlying Security credit event happens, the Structured Note will be redeemed early.
Why were DBS High Note 5 and Merrill Lynch Jubilee Series 3 redeemed while Lehman Minibonds was not?
Lehman Brothers was a Reference Entity in High Note 5 and Jubilee Series 3. Thus, Lehman’s bankruptcy is considered as a Credit Event.
In Lehman’s Minibond case, Lehman is the Swap Counterparty and not a Reference Entity. Therefore there was no Credit Event. The trustee, HSBC Institutional Trust has the option to look for a substitute Swap Counterparty in the interest of the Note-holders.
Lehman Brothers was a Reference Entity in High Note 5 and Jubilee Series 3. Thus, Lehman’s bankruptcy is considered as a Credit Event.
In Lehman’s Minibond case, Lehman is the Swap Counterparty and not a Reference Entity. Therefore there was no Credit Event. The trustee, HSBC Institutional Trust has the option to look for a substitute Swap Counterparty in the interest of the Note-holders.
Are the affected Structured Notes Principal Protected?Some of the Notes state that they are Principal Protected while others don’t. However, Principal Protected does not mean that the investor WILL get back the Principal at maturity. It just means that the issuer will attempt to protect the principal.
In the case of a Principal Guaranteed note, the principal is guaranteed by the issuer or a third party. In the event that issuer/third party faces bankruptcy, the investor may still lose his principal.
Read the blog entry Capital Protected is NOT Capital Guaranteed under the related post below for other examples.
In the case of a Principal Guaranteed note, the principal is guaranteed by the issuer or a third party. In the event that issuer/third party faces bankruptcy, the investor may still lose his principal.
Read the blog entry Capital Protected is NOT Capital Guaranteed under the related post below for other examples.
