Wednesday, February 27, 2013

SEC Issues Letter Regarding Structured Product Valuation Disclosures

By Tim Dulaney, PhD and Tim Husson, PhD

Bloomberg's Kevin Dugan is reporting that the SEC has issued a letter to issuers of structured products late last week that offers guidance for the disclosures of estimated value in offering documents. The SEC letter addresses the concerns we and others have shared over the potential mispricing of structured products, which can be and are sold to retail investors--you can find our research papers on the topic here.

The letter confirms that the SEC will require--though it is not clear exactly when--that structured product issuers disclose their estimation of the fair value of the product as of its pricing date.  Some issuers, such as Goldman Sachs and Bank of America, have already started disclosing fair values on some of their products.  According to Kevin, this letter requires that issuers to exclude most of the commissions and hedging costs associated with the structuring and sale of the notes.  As a result, the issuers will be required to state a value for the product that is derived from the value of its components.

To see an example of how a structured product can be decomposed into several derivatives, such as a fixed-income bond and several options contracts, consider our recent structured product report on the Buffered SuperTrack Notes (PDF) issued by Barclays late last year.  On page 4, we decompose the valuation into its derivative components and value each component separately, then add those values together to value the note itself.  Unfortunately, the issuer valuations we have seen so far only report the bottom-line valuation for the product as a whole, not the value of each embedded derivative.

Nevertheless, these new requirements are a significant step in the development of structured product regulation in the US, and should call attention to the repeated finding in the academic literature that structured products tend to be issued at a premium to fair value.  We will monitor these new valuation disclosures closely to assess their impact on the structured product market and on investors.

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