Solution to "I-Kill-U-Later" Risks

I thought it might be worthwhile to record this suggestion HERE, so it would be easier to find:


(I was writing about a Note which someone called a Structured Note - and along the way proposed a means of communicating the Risks inherent in Notes like the Accumulators.)


No,

It is not a "Structured Product" - just a straight Note with nothing special but Tethys Credit risk.



I know all about "structured products", since I used to have a Senior derivatives job for a major Global bank. I generally AVOID them, because the risk is nearly always mis-priced, the customers are getting ripped off. Unscrupulous bankers imbed a Put or Call option in a note, and then give back maybe half of its real value in a higher interest rate.



I tell the idiot bankers who try to sell me these things: Have you PRICED the risk you are asking me to take? If I want to take that risk, I will just sell the option myself. Then I get more money for it, and can manage it more effectively - In a strucured note, I am just stuck with it.



Mostly these things, like I-Kill-You-Laters, have huge assymetrical risk, where the client can lose 10X or 20X or more than the benefit he gets if things move the wrong way.



If I was a Hk regulator, I would attack these abuses with a simple message in red at the top of the document:



THIS INSTRUMENT HAS ASSYMETRICAL RISK:

IT IMPROVES THE CLIENT'S INTEREST RETURN BY $x,xxx OVER THE LIFE OF THE NOTE, IN EXCHANGE FOR THAT IMPROVEMENT THE CLIENT COULD LOSE UP TO XX TIMES THAT ON HIS ULTIMATE CAPITAL RETURNED.



Such a brief warning would be far more useful than a multi-page document, and it would cut straight to the risk issue involved. The bankers would hate it, because they would sell less product, but it would force them to have exactly the sort of conversation they should be having with clients.



(Please feel free to copy this, and send it to the HK regulator. These guys have failed to do their jobs properly, and clearly need help !)

Here's the discussion that led to this post, as first posted on the Hong Kong Property Advice, "Don't Buy a New Property" thread:

OTP:

The Notes were issued by TXXXX and are "secured" by a lien on a drilling rig. They also include a warrant, which I did not count (yet) in my return, which has gone up in value since the transaction closed.


Such opportunities are not easy to find, nor does everyone see the potential. When we did the transaction, I showed it to 3-4 friends, and they all declined. They simply could not get their minds around it.


LGMV:

OTP Sounds like a highly illiquid structured product. Did you buy from a mainstream bank or broker? It's just that there lots of scams out there.


http://hongkong.asiaxpat.com/forums/hong-kong-property/threads/146307/dont-buy-a-new-property/

EVEN BIG BANKS have problems managing complex risks,

so individuals should know what the "worse case" is, that they are facing.


This just out:


JPMorgan Chase discloses $2-billion trading loss


Critics of Wall Street lost no time in calling for regulators to proceed with cracking down on big banks such as JPMorgan, which began the year with $863 billion in federally insured domestic deposits.


"The enormous loss JPMorgan announced is just the latest evidence that what banks call 'hedges' are often risky bets that so-called 'too big to fail' banks have no business making," U.S. Sen. Carl Levin (D-Mich.) said in a statement.


This "is a stark reminder of the need for regulators to establish tough, effective standards to protect taxpayers from having to cover such high-risk bets," he said.


Bank lobbyists had argued that the biggest U.S. banks need more flexibility if they are to compete against global financial giants. But the latest debacle provided new fodder for critics.


At a minimum, JPMorgan's admission shows that large and unforeseen losses can erupt at any time despite the banks' efforts to limit risk-taking.


"It demonstrates that even at an institution like JPMorgan, which has done a remarkable job at staying out of trouble compared to other banks, a bolt out of the blue can come at any time," said Anthony Sabino, a law professor at St. John's University in New York.


The problems at JPMorgan stem from the trading of synthetic credit products, which are derivatives whose values are tied to a portfolio of underlying bonds. The bank lost money when it was trying to unwind these exotic instruments, which were originally intended to hedge JPMorgan's credit exposure.


http://www.latimes.com/business/la-fi-0511-jpmorgan-chase-20120511,0,4625412.story