Aug 31, 2011

Advanced Valuation and Risk Modeling for COE- Structured Notes for the Brazilian Market

On August 23rd, Numerix hosted a complimentary webinar where the key takeaway from this webinar was: As the Brazilian Structured Products market eagerly awaits the opportunity to offer COEs into the market, concerns still remain about the risk management of the products, accounting treatments and the structured elements of the notes.

The presentation started with James Jockle, Senior Vice President of Marketing from Numerix, who highlighted the following key points of the webinar:

  1. Capturing volatility in the pricing of Brazilian Equity Baskets.
  2. Effective risk measurement and scenario analysis.

Keith Styrcula, Chairman of the Structured Products Association, also said that, “Brazil has the potential to experience the fastest growth in the issuance of structured investments- more so than any other country in the world.” However, the regulatory framework in Brazil that governs the marketing and sales of structured investments (especially of retail customers) is underdeveloped. Globally, many jurisdictions are dramatically tightening the regulations governing structured investments- the UK, US, Japan, Hong Kong and the EU. The biggest challenge is: As the structured investments market develops in Brazil, how might the regulatory framework evolve?

Mr. Styrcula gave the example of the global regulatory framework, post-2008 (Lehman Default) and further asked the audience: Could an adequate regulatory framework have prevented many of the losses of holders of Lehman structured investments? Regardless, it was clear that many of the jurisdictions had inadequate safeguards for retail investors. A redefinition of “principal protection” in the context of corporate bankruptcy would have been timely. The United Kingdom’s KID (Key Information Document) was meant to simplify the terms of a structured investment.

The Re-Examination of Global Regulations includes:

1. New Rules- FINRA drafted three new Notices to Members regarding various types of structured investments in the last year. More rules are coming.

2. New Laws- The U.S. Congress enacted the Dodd-Frank legislation to cover derivatives and hedging of structured investments.

3. Enhanced Surveillance- The SEC undertook a sweep of structured investment issuers in 2009 and published its findings last month. FINRA made inspections of structured investments efforts one of its top three priorities in 2010 and 2011.

4. Private Legal Actions- In the United States, class action lawyers have sought to hold UBS responsible for the bankruptcy of Lehman principal protected notes.

 

Valuation and Risk Modeling for Certificado de Operações Estruturadas (COEs)– Structured Notes for the Brazilian Market

Horacio Aliaga, Financial Applications Developer from Numerix, said he was also excited about the release of the structured notes in the Brazilian Market, and he presented an example of Brazilian Structured Notes. He even said that we can validate financial instruments with Numerix Models. He gave two scenarios:

Below is an example using Numerix:

 

 
 

Scenario 1:

If a Kick-in Event does not occur on or before Final Validation Date, or if a kick-in event occurs before the Shares have an Expiry Price on the Final Validation Date that is above their respective Strike Price, the investor will receive the par value of the Note on the Maturity Date.

Scenario 2:

If a Kick-in Event has occurred on or before the Final Validation Date, the following redemption scenarios occur:

-If, on the Final Valuation Date, all Shares close above their respective Strike Prices the Investor will receive the par value of the Note on the Maturity Date

-If, on the Final Valuation Date, one or more of the Shares closes at or below the Strike Price, then on the Maturity Date, the Investor will receive a predetermined number of Shares with the lowest return per BRL 1,000 Note as follows:

Number of Shares= Number of Worst Performing

“Kick-in-Event” means that, at any time on any exchange business day during the period from the Issue Date up to and including the Final Valuation Date, the prices of any of the shares quoted by the Exchange are equal to or less than their respective Barrier Prices.

This finally concluded the webinar with Keith Styrcula, Chairman of the Structured Products Association, James Jockle, Senior Vice President of Marketing from Numerix and Horacio Aliaga, Financial Applications Developer from Numerix.

To learn more about how Numerix can help with the valuation and on-going risk management of all types of structured products, contact sales@numerix.com.

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