Sebi stops structured products without capital protection

Directs rating agencies not to cover these products.

The Securities and Exchange Board of India (Sebi) has asked credit rating agencies not to rate non-capital protected structured products, putting an end to issuance of these instruments.

Since the order was issued some weeks ago, no rating agency had been covering these products, said people familiar with the matter, on condition of anonymity.

“Sebi is not comfortable with these products,” said an official of a rating agency.

“A non-capital protected structured product carries both credit and market risk. When we rate these products, we comment only on the credit risk. Because of this, there is a possibility of misunderstanding among investors,” said another official of a credit rating agency.

Without rating, it has become difficult for issuers to sell these products to clients. “The issuance is zilch at present. Prior to Sebi’s order, about 20 per cent structured products sold in India were non-capital protected,” said a senior official of a foreign bank.

Credit rating is also required for listing of structured products in the wholesale debt market segment of stock exchanges. This provides an exit route to original investors, typically towards the end of the product’s tenure. For example, if a structured note has a 24-month tenure, high net worth individuals (HNIs) and mutual funds buy from the original investor a few weeks before it expires to get a better yield without taking much risk.

A structured product is a pre-packaged strategy in which value is derived from the performance of various underlying assets such as equity indices, a basket of stocks, commodities, interest rates or currencies. In a capital-protected structured product, an investor gets back his principal amount at maturity irrespective of the performance of the underlying asset, subject to the credit risk of the issuer.

In a non-capital protected structured product, the principal amount is not guaranteed. This exposes an investor to the risk of losing his capital.

In India, mostly equity-linked and gold-based structured products are sold to HNIs. Barclays Capital, Citibank, JP Morgan, JM Financial, Kotak Securities and Edelweiss Capital are the major issuers of structured notes in India.

There is no official data about the size of the structured products market in India. Industry officials peg it at over $1 billion (Rs 4,700 crore) a year.