One of the key risks in structured products is counterparty risk – the risk that the financial institution providing the capital preservation element (the counterparty) cannot meet its obligations to investors when they fall due. In general and all things being equal, the less secure the institution, the better the headline rate or reward on offer – a typical risk/reward trade-off seen in most investment products.
The purpose of this section is to outline different considerations for counterparty risk in structured investments, and to provide information that may be useful for your firm when completing due diligence on Absa Bank Ltd or Barclays Bank Plc as an issuer.
Counterparty risk simply means the risk that a counterparty in a legal agreement will fail to meet its contractual promises. There are two main types of counterparty involved in providing and/or accommodating a structured investment for a client. These are the issuer, such as Absa or Barclays, who provides the securities that make up the investment and commits to paying the client the returns offered in the investment final terms. The second type is the administrator, like a plan manager or wrap platform.
By investing in a structured product, a client is essentially lending their capital to the issuer(s) for the term of the investment. The issuer uses the client’s capital as a form of funding, not dissimilar to bonds or deposits, and in turn promises to pay the client the terms of the investment as described in the final terms, including any returns and capital repayment.
The administrator takes a proportion of the client’s investment for providing their services. These charges may be contained within the terms (as is the case with a plan manager) or they may be charged outside of the investment itself (a wrap platform or SIPP provider, for example).
This section focuses mainly on the risk that the issuer is unable to pay the client the promised returns and capital repayment of a structured investment.
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