German structured products to receive rating scrutiny

The rating system is expected to be welcomed by German investors, who often struggle to see the wood for the trees when it comes to assessing the more than 300,000 certificates on offer in the country.

Ratings will be calculated by the Zurich-based European Derivatives Group (EDG), an independent training and information provider for structured products. The system recognises five risk categories ranging from one (risk averse) to five (speculative), based on value at risk (VAR) figures. Assuming an investment sum of €10,000, a 99% confidence level and a 10-day holding period, risk class one comprises products for which VAR is between €0 and €250, risk class two includes products with VAR between €250 and €750, in risk class three fall products whose VAR lies between €750 and €1250, while class four and five include VAR figures of €1250- €1750 and €1750 – €10,000 respectively. The product ratings will also be modified depending on information availability, trading, costs and the credit rating of the issuer.

While some of the factors influencing the ratings are expected to be fairly stable, such as information availability, which indicates the ease with which product information can be found on issuer’s websites, or the issuer's credit rating, changes in market parameters can have significant consequences for certificates. For that reason, the ratings will be updated on a monthly basis, with the possibility of shorter frequencies in extreme situations.

It is therefore possible that as, for example, market conditions deteriorate, a product will move from risk class one into risk class three, acting as a warning sign for fund managers. One example would be a bonus certificate, which is a barrier certificate with a bonus feature. If the barrier is knocked in, the certificate redeems in the shares in the underlying. In a falling market, as long as the certificate does not hit the barrier, its price will not change. However, the closer the market falls towards the barrier, the riskier the product becomes and at some point it could prove wise to sell the certificate. The rating will flag these increasing risk stages.

The certificate rating system has been developed at a number of German universities, including the Otto Beisheim School of Management in Vallendar. It is also promoted by the Deutscher Derivate Verband (DDV), the country’s derivatives association and, while it is not obligatory for German structured product providers to participate in the process, feedback from banks has so far been positive, according to the system’s developers. The system has been designed and is expected to be up and running by the middle of 2008.

See also: Uncertain certificates 
German tax change sparks new certificate issuance

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