21st Century Business Herald reporter Tang Yaohua Shenzhen reported that Mr. S, an investor, recently reported to this platform that he invested in a snowball structure private placement product with a huge loss of more than 40% after maturity, and the snowball product is linked to the Hang Seng Technology Index. "The Hang Seng Tech Index is indeed falling this year, and the product has been knocked in, and the loss is understandable, but the loss is also too large, much larger than the decline of the Hang Seng Tech Index itself. Mr. S expressed his frustration.
In the course of enquiring the product manager about his suspicions, Mr. S was informed that the investment part of the product was also subject to "exchange rate risk", i.e. the investment loss was further magnified by the depreciation of RMB against the Hong Kong dollar. However, Mr. S said that he was not aware of this risk at the stage of purchasing the product, including the subsequent operation stage of the product, and that the investment loss in the product structure was magnified by the depreciation of the exchange rate, but the principal part did not enjoy the benefits of the appreciation of the Hong Kong dollar.
Is it because the risk of the snowball product itself exceeds the general understanding of investors, or is the risk warning and information disclosure of the manager in the financial investment case insufficient?
Focusing on this dispute, "21 Financial Private Lessons" recently interviewed Mr. S, the manager, and relevant professionals who are familiar with snowball structure products.
Incomprehensible losses
Snowball structured options are a popular derivative product in recent years, usually issued by brokers. One of the non-principal-protected snowball option products usually uses "knock-out price" to frame the upper limit of the fluctuation range and "knock-in price" to frame the lower limit of the fluctuation range, as long as the underlying underlying breaks through the upper limit (knock-out price) or fluctuates between the upper and lower limits, you can get coupons, but if the underlying does not rise to the upper limit, but turns around and falls below the lower limit, it is possible to lose money.
The typical snowball structure includes five elements: pegged target, knock-out price, knock-in price, coupon and knock-out observation date, usually set a knock-out observation day every month to observe whether the closing price of the linked target is greater than or equal to the knock-out price, as long as it is greater than or equal to the knock-out price, the product will be terminated early to obtain considerable coupon income. If you knock in but not knock out, there is a risk of loss.
Mr. S's above-mentioned investment in an over-the-counter option issued by a leading brokerage firm through a private equity fund is a snowball structured option. The option sets the opening price of 5925.52 (the closing price of the Hang Seng TECH Index on December 3, 2021), the knockout barrier price multiplied by 103% of the initial price, corresponding to the Hang Seng TECH Index point of 6103.29, and the knock-in barrier price multiplied by the initial price of 75%, corresponding to the Hang Seng TECH Index point of 4444.14 points. Set a knock-out observation day every month to observe whether the Hang Seng Tech Index breaks through the "upper limit", that is, the knock-out price is 6103.29 points. The ultimate investor's return is the following 5 scenarios:
(Drawing by 21st Century Asset Management Research Institute)
It can be seen that as long as there is a knock-out or no knock-in and no knock-out, the investor can get an annualized rate of return of 17.4%, but if it falls below the "lower limit", it is dangerous to knock in, as long as there is no knock-out thereafter, the yield will be 0 or a loss, and the loss is the decline of the underlying Hang Seng Technology Index.
In short, Mr. S's purchase of this product is equivalent to betting that the OTC option will "not fall below 4444.14 points" during the two-year observation period, or even if it falls below it halfway, it can rise back to 6103.29 points or above.
The product is obviously very difficult for investors.
After December 3, 2021, except for a brief break of 6,000 points in the Hang Seng Technology Index on the following trading days, it never reached more than 6,000 points for a long period of nearly two years, falling below the knock-in price of 4,444.14 points on March 8, 2022, and falling to a minimum of 2,720.38 points in October 2022, until the closing price of the Hang Seng Technology Index on December 4, 2023, the expiration date of the option, at 3,759.72 points, a decrease of 36.55% compared with the opening price.
At the level of private equity products, the net unit value of the product on December 4, the expiration date of the option, is 0.5867, which means that investors, including Mr. S, will lose more than 4% if they choose to redeem at this time, which is greater than the 36.55% decline of the linked Hang Seng Technology Index in the same period, which raises Mr. S's questions about the product.
Missing risk warning?
Regarding the large loss of the product, Mr. S's account manager explained that in addition to the loss caused by the decline of the linked Hang Seng TECH Index, the product also has to bear the exchange rate risk. Mr. S said that this was the first time he knew this information and had not been told before.
Even taking into account the exchange rate, the actual loss of this snowball product is more serious than the common method of calculating the return of investment involving the purchase and settlement of foreign exchange.
Mr. S calculates according to the general method: 1 million principal, converted into Hong Kong dollars according to the exchange rate at the time of investment, 1,222,100 yuan, based on the decline of the Hang Seng Technology Index during the period, as of that time (November 17, 2023) the market value of the position will lose to 820,900 Hong Kong dollars, and then converted into RMB according to the exchange rate on November 17, the settlement should be 762,500 yuan, compared with the initial principal of 1 million, the loss margin is 24%.
The calculation method of the product manager is different: only the loss of 401,200 Hong Kong dollars as of that time (November 17) is converted into RMB 372,700 at the exchange rate, and then the principal of 1 million yuan is subtracted from the loss of 372,700 yuan to obtain the market value of its position of 627,300 yuan, which is equivalent to a loss of about 37%.
In other words, in the investment management of this product, the loss part has been amplified by the exchange rate, but the principal part is always RMB. That is to say, "the principal is denominated in RMB, and the profit and loss is denominated in Hong Kong dollars".
From the perspective of exchange rate trends, after the continuous appreciation of the RMB, a wave of depreciation will start in April 2022, corresponding to the appreciation of the Hong Kong dollar, and the exchange rate of the Hong Kong dollar against the RMB will start to appreciate from about 0.8, and the highest price will rise to 0.9377 in September this year. The loss is only denominated in Hong Kong dollars, which means that the loss is magnified with the appreciation of the Hong Kong dollar, which is also the reason why the loss exceeded Mr. S's expectations.
"Usually snowball structured options do not consider exchange rate risk, and the actual decline of the underlying at the end of the period compared with the beginning of the period is the investment loss of the product, even if the underlying index is linked to an overseas index, because the investor invests in the over-the-counter options issued by a mainland brokerage, the investor's investment process usually does not involve the purchase and settlement of foreign exchange, but the brokerage that issues the option needs to go to the offshore market for risk hedging. An analyst told reporters.
A brokerage agency related business people also told reporters that if the snowball product is linked to a domestic index or instrument, there will be no exchange rate risk, and we ourselves, including some other brokerages I contacted, do not involve exchange rate risk.
The person pointed out that this product is equivalent to the double fluctuation of the index and the exchange rate, "the exchange rate risk is not locked is certainly the most convenient, but the risk is greater, if you communicate clearly with investors in advance, I understand that there is no problem in the design of the structure." ”
However, according to the feedback from Mr. S, the investor, he was not informed of this risk during the investment process, and only learned about it when he later found out that the loss was large and asked the account manager for an explanation.
At the same time, the other party explained the reasons for "the principal is denominated in RMB, and the profit and loss is denominated in Hong Kong dollars", one is that it may amplify the fluctuation of the net value of the entire product, and the other is that the appreciation of RMB is expected to be greater than the depreciation at that time.
However, Mr. S also said that he did not know anything about this operation and the reason behind it. The table of OTC option elements in the product brochure only indicates that the option is denominated in HKD and the settlement currency is RMB, and does not indicate that the denomination currency of principal and profit or loss is different.
In fact, during the early operation of the product, Mr. S found that the valuation of the product deviated from the trend of the index, and also raised questions, and the account manager explained professionally from the perspective of valuation model during the communication, "I never said that the deviation of the net value of the product is the reason for the impact of the exchange rate." Mr. S said.
The reporter checked the product materials and found that there is a paradigm clause in the product manual, in the part of "OTC derivatives transactions involving special risks of overseas underlying assets (if applicable)": if the transaction profit or loss of a foreign derivatives transaction is reflected in the form of foreign exchange, when the exchange rate between RMB and foreign exchange fluctuates, investors may suffer losses caused by exchange rate fluctuations.
The above-mentioned institutions said that the risk disclosure book is a paradigm text, market risk, exchange rate risk investment risk, these are the contents of the regular list, but most people will not notice, if no one clearly states when buying, investors will not care too much.
Investment products should have a detailed understanding of the risks involved
The arrangement of "the principal is denominated in RMB, and the profit and loss is denominated in Hong Kong dollars" may also bring the possibility of losses greater than the principal, also taking RMB 1 million for this option investment, the investment start date of December 3, 2021 is converted into Hong Kong dollars of 1,222,100 Hong Kong dollars, if only the loss is settled in Hong Kong dollars, as long as the loss of the investment exceeds 88% (loss of 88%) The corresponding loss of 1,075,400 Hong Kong dollars is about 1 million yuan) may lose 1 million yuan of principal, and continued losses mean that investors not only do not get a penny of principal, but also may owe money to the product issuer.
Due to the investment in option derivatives, such products are often not low-risk. The above-mentioned product brochure shows that the risk level of this product is R4, which is suitable for qualified investors with risk identification, assessment and tolerance of C4 and C5 levels. Mr. S is a professional accredited investor, but even so, he does not fully understand the risks behind the product, let alone ordinary investors.
"21 Financial Private Lesson" reminds investors that when buying products with similar investments or linked overseas targets, it is recommended to consult in detail whether there is an exchange rate risk, and ask the other party to calculate the extreme circumstances that may bring losses. Before buying such snowball structured option products, investors also need to predict the trend of the underlying asset, which is not suitable for buying when the investment target may fall unilaterally, and is suitable for investors with certain investment experience to buy.
At the end of August 2021, the Asset Management Association of China (AMAC) provided window guidance on snowball options for asset management institutions such as asset management companies and fund subsidiaries, requiring that the proportion of investment in snowball structured options for a single product should not exceed 25%, and closed-end pooled plans with all professional investors and a single investor exceeding 10 million yuan can be exempted.
In September 2022, the Asset Management Association of China (AMAC) issued the Announcement on Private Equity Fund Filing Cases, which mentioned cases that did not meet the filing requirements, such as "borrowing" private equity funds to conduct regulatory arbitrage, and mentioned that a securities company designed a "borrowing" private equity fund to invest in snowball structured products, and the fund raising and investment targets of the private equity fund were mainly determined by the securities company, which had obvious channel business characteristics and belonged to regulatory arbitrage.
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