Structured note sales could be affected by the recent downgrade of the Société Générale and Credit Agricole credit ratings by Standard & Poor's (S&P) say issuers approached by SRP.
"The biggest risk is not the downgrading but the noise around it in the market," said a senior executive from an investment bank who wanted to remain anonymous. "We have heard from providers with exposure to SocGen paper getting calls from worried investors. Right now no one will buy or sell SocGen, Credit Agricole or even BNP paper at any price, but this kind of situation also affects other banks because on a bank-to-bank basis providers and investors will be more careful on taking any risk."
Another banker from a US investment bank said the impact of the re-rating will reach every issuer because of the credit risk issue around structured notes: "If the noise is around, any bank that is a big issuer of structured notes [not only the French banks] will be affected because we are being hit day in day out with different news about the creditworthiness of issuers," he said. "In our conversations with people we are finding that the golden talk is around alternative wrappers that take you out of that kind of conversation. Providers may look more and more to other alternatives such as Ucits III funds, structured funds or collateralised-type issuances."
According to a structured products executive from one of the highest rated issuers in the market, the downgrade will have a direct impact on French banks' issuance in general: "It will be more expensive for them to buy debt in the market and the secondary mark to market will also be negative as the credit risk will be reflected in the valuation of those existing products," he said. "For new products it could be beneficial as they may have more cash to spend in the options [as they will be buying debt at a higher rate], but I think issuance of new products will also be affected as clients will shy away. These days very few providers would deal with low-rated issuers."
The same source said that even if a distribution team wants to sell certain notes by lower-rated issuers with better funding they will not be able to go ahead because of internal restrictions. "Clients will be asking themselves if it is justified to stick to those downgraded issuers or if it is better just to diversify," he said. "You will have to justify internally to risk-management and compliance that you are dealing with providers with a low credit rating," he said. A UK distributor that has sold products hedged by French banks in the past agreed with this view. "We have seen platforms saying they will only deal with AA and higher, others will say single A or better, and you can make a case or an exception - but in general compliance and control functions will have the last word on who you deal with over the commercial aspect."
Another source said the question is how market makers deal with the situation. "If they suddenly start getting a lot of redemption orders they can either maintain the bid levels and absorb whatever flow comes back ... but I have seen situations where people in the secondary market will stop answering their phones or disappear for a week," he said. "If they pull back the bid dramatically it will escalate the problem because then people will be more nervous, so the best strategy is to stand up and face the problem, although if the credit spreads widen and you pull the bids straight away into the secondary market you can find yourself in trouble very quickly."