Structured products in practice
March 3, 2016 2:39 PM Subscribe
Structured products/notes liquidity IN PRACTICE (kind of technical)
The standard risk warning for structured products (notes and CDs) is that they may not be listed on an exchange and may be thinly traded. The issuer may make a secondary market but is under no obligation to do so. They should be considered illiquid or as having limited liquidity.
I need to know how this works IN PRACTICE and can't find an answer. If a brokerage platform allows someone to enter an order to sell a structured note, how hard are they to sell on the secondary market? Are they all thinly traded or is there a difference based on issuer/type/structure/whatever? Are some pretty easy to sell and some not? If they are somewhat easy to sell, is it often at a huge discount (I would call this effectively illiquid, if it can't be sold without a big hit)? Are there other market makers or is it just the issuer making the market?
Really would like some clarity on this as the ability to sell something on a brokerage trading platform could indicate some liquidity, but if it's very thinly traded or can only be sold at a huge discount, I would still call that effective illiquidity.
The standard risk warning for structured products (notes and CDs) is that they may not be listed on an exchange and may be thinly traded. The issuer may make a secondary market but is under no obligation to do so. They should be considered illiquid or as having limited liquidity.
I need to know how this works IN PRACTICE and can't find an answer. If a brokerage platform allows someone to enter an order to sell a structured note, how hard are they to sell on the secondary market? Are they all thinly traded or is there a difference based on issuer/type/structure/whatever? Are some pretty easy to sell and some not? If they are somewhat easy to sell, is it often at a huge discount (I would call this effectively illiquid, if it can't be sold without a big hit)? Are there other market makers or is it just the issuer making the market?
Really would like some clarity on this as the ability to sell something on a brokerage trading platform could indicate some liquidity, but if it's very thinly traded or can only be sold at a huge discount, I would still call that effective illiquidity.
Retail structured products are about as liquid as diamond engagement rings.
posted by jeb at 7:12 PM on March 3, 2016
posted by jeb at 7:12 PM on March 3, 2016
Response by poster: Thanks for the replies. I'm not planning on buying them or inducing anyone to buy them. I realize my question is super specific and kind of a long shot, which is why I asked - I've had a hard time finding an answer. I just need to know how the liquidity is in actual practice, outside of the standard liquidity risk warning. There's a pretty specific reason I want to know, which doesn't have anything to do with actually investing in them.
posted by triggerfinger at 9:04 AM on March 4, 2016
posted by triggerfinger at 9:04 AM on March 4, 2016
Best answer: It depends on the specifics of the investment. In order to know what kind of liquidity you would actually find, you need to know the industry, the place of the issuer within the industry, the financials of the issuer, the country in which the investment is located, the structure of the investment. For example, consider the distinctions among (i) a second lien loan on a single piece of real estate in Monaco, (ii) shares issued in a public company in Germany that are subject to a six-month lock up, (iii) super-priority DIP financing in a prepackaged Chapter 11 reorganization of a company with cash flow issues but otherwise good metrics. Then there was the grey market in facebook shares before the IPO. Apparently, people were more or less able to sell whenever they wanted.
Liquidity risk can be any of the factors you mention. Some liquidity issues relate to the regulation on insider sales of otherwise publicly traded securities, and the cost of those sales is often quantifiable as the cost of a legal opinion that the trading restriction period has ended on the shares to be sold. On the other hand, I've seen liquidity discounts up to 40 percent, and that doesn't even take into account other risk factors. If you have a large investment in a position that is thinly traded, you might get a double discount based on the fact that you are flooding the market and forcing the price down.
I think the reason it's hard to find a specific answer is that you have to model the actual investment you're talking about.
posted by janey47 at 11:11 AM on March 4, 2016 [1 favorite]
Liquidity risk can be any of the factors you mention. Some liquidity issues relate to the regulation on insider sales of otherwise publicly traded securities, and the cost of those sales is often quantifiable as the cost of a legal opinion that the trading restriction period has ended on the shares to be sold. On the other hand, I've seen liquidity discounts up to 40 percent, and that doesn't even take into account other risk factors. If you have a large investment in a position that is thinly traded, you might get a double discount based on the fact that you are flooding the market and forcing the price down.
I think the reason it's hard to find a specific answer is that you have to model the actual investment you're talking about.
posted by janey47 at 11:11 AM on March 4, 2016 [1 favorite]
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Liquidity is only one of the problems, but it is a problem. The issuer is unlikely to be "making a market" in the traditional sense--that is, generally accepting buy and sell orders within a certain spread and thus probably carrying some of those notes in their own inventory for some time. Why would they do that? They have already offloaded the crap onto you, the sucker. Sure, these notes are traded on the secondary market from time to time, but you can't rely on it, and you especially can't rely on there being buyers under many of the circumstances when you'd want to sell (that is, when the perceived value of the notes drops).
posted by praemunire at 5:48 PM on March 3, 2016