Understanding structured notes

What are structured notes?

A structured note is a debt product whose return is linked to the performance of one or more underlying assets or benchmarks. It may be the interest that is payable on the structured note and/or the principal repayment, that is linked to the performance of the asset or benchmark.

A structure note is a complex product and there are other factors which can affect its performance. For example:

• The credit risk of the issuer as well as the credit risk of various counterparties of the issuer

• Changes in the value of any collateral provided

If the asset or benchmark underperforms, you may suffer a loss on your returns or even principal invested.

While some structured notes may attempt to preserve the value of the capital invested by providing collateral, there is no guarantee that the principal amount invested will be returned to you.

It is important that you read and understand the Product Highlights Sheet and Prospectus to understand the product’s features and risks.

Structured note VS structured deposit

Structured note investors may potentially lose the whole amount invested in a structured note. But if you invest in a structured deposit, you will at least receive the principal amount deposited on the maturity of the structured deposits (subject to the credit risk of the bank).

Underlying assets or benchmarks

The underlying assets or benchmarks are sometimes referred to as reference assets or reference benchmarks.

These assets or benchmarks may include:

• Market indices

• Equities

• Interest rates

• Fixed-income products

• Foreign exchange rates

• Commodities prices

• Any combination of these

There are also structured notes with returns linked to two or more reference assets or benchmarks (for example, the interest amount and/or principal repayment are dependent on both the creditworthiness and the share price of a group of companies).

Types of structured notes

Returns from structured notes

A structured note is a debt obligation of the issuer of the structured note. The issuer of the structured note usually pays interest or returns to investors during the term of the notes.

The interest paid may be a fixed coupon or calculated according to a formula which is linked to one or more underlying reference asset(s) or benchmark(s).

Read the Product Highlights Sheet and Prospectus carefully to understand the conditions affecting interest or principal payments. Ask questions and ensure that you understand the information in the documents before deciding whether to invest in the structured note.

Why invest in structured notes?

Structured notes often offer investors potential returns that are higher than interest rates offered on traditional deposits. They may even offer the potential for capital appreciation.

But such returns or capital gains are dependent on the performance of the underlying reference asset(s) or benchmark(s), which in turn exposes the investor to a greater variety of risks than a traditional deposit would.

What are the risks?

An investor will lose money if:

• The underlying asset or benchmark underperforms, e.g., if the price, value or level of the underlying asset or benchmark does not move in the direction and/or by an amount sufficient to produce a return under the structured note

• The issuer of the structured note defaults on its commitments under the structured note

Structured notes are usually embedded with derivatives such as options or swaps. These instruments provide the link between the note’s overall return and the performance of the underlying reference asset or benchmark.

While structured notes may offer higher potential returns, the investor takes on greater risks when investing in such products. The swap or option involves a contract between the issuer of the structured note and another institution (the counterparty).

Risks arising from the derivative instruments, including the failure of a counterparty to meet its obligations, may be passed on directly to the investor and may result in the total loss of the original investment amount.

What’s the most you can lose?

Most structured notes are not principal-guaranteed. You may lose all or a substantial amount of the money you invested in certain situations, which are described in the Product Highlights Sheet and Prospectus.

The principal repayment or the interest payable, or both may be linked to the performance of an underlying asset or benchmark. If the asset or benchmark underperforms, you may suffer a loss on your returns and the principal invested.

Your return may also be affected if your structured note is redeemed early by the issuer, or for other reasons specified in the prospectus for the structured note.

Early redemption

Many structured notes allow the issuer to redeem or “call” the notes before maturity. When this happens, the notes would normally be redeemed in full.

If an early redemption takes place, you may face reinvestment risk and loss if you are unable to reinvest the principal received at equally attractive returns.

The structured notes may also be redeemed early if:

• There is an event of default e.g. if the issuer fails to meet payment obligations under the structured note

• Taxes are imposed on the issuer or on payments from the note

• An extraordinary or force majeure event occurs (these are described in the prospectus for the note)

• The market value of any collateral falls and is insufficient to secure any or all obligations under the structured note.

In these circumstances, you may lose all or part of the amount you initially invested.

Fees and charges

The issuer may charge a fee for the management of the reference assets of the structured note and for the hedging of the risks relating to the changes in value of such assets.

A list of all such fees and expenses, which are usually payable out of the returns generated by the reference assets, should be disclosed in the prospectus for the structured note.

If the structured note is traded on an exchange, the trading of the note will incur clearing and trading fees, as well as commission fees imposed by individual brokers.

Documents you should receive

If you are offered a structured note, you should receive a prospectus and Product Highlights Sheet.

Prospectus

Issuers who offer structured notes to retail investors are required to provide a prospectus to investors. Read the prospectus carefully to understand the details of the offer, information on the issuer, risk factors, and the terms and conditions of the structured notes.

Product Highlights Sheet

In addition to the prospectus, the issuer should also provide you with a Product Highlights Sheet. The Product Highlights Sheet is a short document which highlights key features and risks of the structured notes, and usually incorporates diagrams such as graphs and flowcharts to explain the structure or payoffs of the structured notes.

The Product Highlights Sheet does not replace the prospectus. It is important to read the prospectus before deciding whether to purchase the product.

Checklist

Investing in structured notes may not be for everyone. Before you invest, check that you:

• Want potentially higher returns but are also prepared for variable returns which include the risk of losing all or a substantial part of the money you invested

• Understand how the returns are calculated or are clear about the factors and scenarios that can affect returns

• Understand the risks associated with the structured note. Structured notes may use derivatives to hedge risks or to improve performance. Investors should be aware of the risks associated with the use of derivatives, including the risk that the provider or counterparty of the derivative defaults

• Understand the full extent of the credit risks associated with the issuer, as well as risks associated with any assets referenced in the note

• Are prepared to leave your money tied up until the maturity date of the note or do not have short term needs for the money

• Are prepared for your investment to be redeemed earlier, whether at the issuer’s option or for other specified reasons. An early redemption of the structured note may result in you losing all or part of your original investment