Structured products: where the risk is hidden

The risk of a structured product does not lie in the underlying asset pictured on the marketing sheet. It lies in the creditworthiness of whoever promises you the payout, in the set of conditions under which the promised protection stops working, and in the price at which you will be let out of the product before maturity. The underlying asset is merely the reference for the calculation. The obligation to pay rests with the issuer of the note, and it is the issuer's credit quality that determines whether you receive anything at all.

What the product is built from

Almost any structured note can be broken down into a debt component and a derivative component. The debt component is the issuer's obligation to repay the face value, or an agreed share of it, by the maturity date; economically it is close to a regular bond of the same issuer. The derivative component is an options structure linked to the underlying asset: an index, a basket of stocks, a currency pair or a commodity. The coupon that is not paid out on the debt component funds the purchase of the options. A simple consequence follows: the higher the promised "yield" in the terms, the cheaper and more exotic the option that has been bought, and therefore the lower the probability that it will pay off at all.

Understanding this breakdown matters more than any table of scenarios. Once you see which parts a note is assembled from, it becomes clear which questions to ask: who is the debtor on the debt component, and under what conditions does the derivative kick in.

Who owes you: the issuer, not the market

When you buy a note linked to an index, you do not own the index. You own a claim on the issuer whose value is calculated with reference to the index. If the issuer stops paying, the underlying asset can trade as high as it likes — there will be no payout. This is the main and most underestimated risk of the product: credit risk.

This leads to a practical rule. Before reading the payout scenarios, check the yield at which the ordinary debt securities of the same issuer or its group are trading. The comparison should be made against a benchmark — the OFZ curve and the rest of the bond market. If the market prices the issuer's debt as risky, its note carries the same risk, only without an explicit price tag.

A separate point: a structured note is not a bank deposit and is not covered by the deposit insurance scheme, even when it is sold in a bank branch and labelled "protected".

"Capital protection" is a condition, not a feature

The phrase "capital protection" in a prospectus almost always means that the issuer undertakes to repay the face value provided that a specified event has not occurred during the life of the product. The event may be a barrier event (the underlying asset touched a certain level), an observation-date event (the value is below a threshold on the fixing date) or one linked to the worst-performing security in a basket.

The "worst-of basket" structure deserves a closer look. The payout is calculated on the weakest asset in the set, not on the average. Adding new names to the basket raises the promised coupon precisely because it raises the probability that at least one of them will fail. A basket is not diversification; it is the opposite — selling protection on every one of the names.

Autocall, coupon and asymmetry

With autocallable notes, the issuer redeems the product early when the underlying asset moves in your favour — you receive the agreed coupon but give up all further upside. When the asset moves against you, the product runs to maturity and you bear the loss on the underlying asset. Gains are capped; losses are not. This is not a flaw of a particular product but its very design, and it is what pays for the promised coupon.

What you do not receive

An equity-linked note almost never passes on dividends. The payout is based on the price, while the dividend stream stays with whoever holds the hedge. On the Russian market this is a substantial part of total return: see for yourself which payments are coming up soon —

And the dividend calendar. The same logic applies to coupon-bearing securities: the coupon of the underlying asset is not included in the calculation.

The fair comparison is therefore not "note versus deposit" but "note versus a simple portfolio of the same underlying asset plus a debt security of the same issuer". The difference is the price of the structure. To compare it with ready-made instruments, the funds section is useful.

Where the seller's fee sits

A structured product usually has no separate line labelled "fee". The fee is built into the price: the options inside the product are valued in the issuer's favour, and the note is sold for more than the sum of its parts. The absence of an explicit fee does not mean there is no fee — it means you cannot see it without taking the product apart yourself.

Exiting before maturity

Most notes have no secondary market. Buybacks happen at the issuer's price, that is, at the price set by the very party that stands to gain from your exit. In a calm market the gap to the fair value is tolerable; under stress it widens — exactly when you need the money. The term of the product should be treated as fixed: plan for it as money that is locked up, not as a position you can close.

Taxes and documents

Payouts on a note are income from a security or under a contract, not the return of a deposit; the tax base is calculated under the rules of 13%. The tax breaks familiar from long-term holding of shares do not automatically apply to structured products — that depends on the specific security and the form in which it is issued.

What to read before signing

Step 1 — find out who is legally obliged to pay and see how the market prices that party's debt. Step 2 — write down every condition under which the protection stops working, and how the barrier is observed. Step 3 — check whether the payout is calculated on the worst-performing asset in the basket. Step 4 — find the early redemption procedure and who determines the price. Step 5 — work out what you are giving up: dividends, coupons on the underlying asset, the cap on upside.

If any of these points is not disclosed in the documents, that is your answer to the question of where the risk is hidden.

A caveat in the interest of honesty: the site does not store the terms of individual notes or their historical payouts, so we have nothing on which to base typical parameters for the structured products market — they have to be checked against the documents of the specific issue and the issuer's financial reports. The terms used in these structures are explained in the glossary.