Recovery: Barrier breached – close your eyes & just keep going?

No investor likes barrier breaches, as this often results in a loss.

Financial markets are going through a hard time at the moment. Restructuring the product could be the right solution in these cases. Exogenous shocks constantly remind investors that anything is possible in financial markets. It is therefore essential for investment advisors to show clients all the possible scenarios that may occur during or at the end of the tenure of a structured product. These considerations apply both to the individual product in isolation and in the context of the overall portfolio.

Restructuring products creates time for reflection

If the investor expects a price appreciation of the underlyings, a recovery strategy might be the right solution. Restructuring in this context means, that the investor sells the existing product at market value and buys a new product, which is adapted to the new circumstances and market expectations. In this way, the investor has the opportunity to recover the originally invested capital. The “new” product can be structured, for instance, with a longer maturity and a barrier, which, if touched, is only observed at expiry (European style barrier). The new restructured product is issued at the same price that would be achieved on sale or roll over.

This procedure is known as a recovery strategy. Since the first priority in the event of a barrier breach is the recovery of the capital originally invested, the new expected coupon can be reduced to a minimum. Together with the increased volatility, a restructured product can be constructed without additional financial commitment on the part of the investor. Should the underlying still be trading below the new barrier level at the new final fixing, the investor would be exposed to the same downward risk as with the original product. Should the medium-term expectation for the breached underlying be negative, we would find it more sensible to incur the loss by selling the position.

Case study of a recovery measure on BRC

Current: BRC on ZURN with barrier breached

Spot reference price: CHF 398.30

Recovery measure: Barrier Discount certificate on ZURN

Spot reference price: CHF 264.70

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