Subordinated Risk Swap
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Subordinated risk swap, also called equity risk swap or equity default swap , describes in business the right to transfer risk from the ownership of a thing, mostly shares and company shares , but also risks from the associated managerial or organizational activity. It is based on a structured option business . Subordinated risk swaps are therefore classed as swap options (swaptions).
features
Option holder
The option holder, or subscriber of the option, acquires the right to sell the underlying asset to the writer under the conditions defined in the option contract . This gives the option holder the option of risk transfer at the expense of the writer. The option holder compensates the writer for this with an option premium, the option price.
Writer
The writer or option giver undertakes, in return for payment of the option premium, to acquire the underlying asset on the specified key date at the conditions defined in the option contract, and therefore assumes the risk (possibly up to a resale).
Underlying
The base value or option subject (English underlying is) of the option transaction underlying value to be transferred from the option holder to the writer. In the course of the structured option business of a “subordinated risk swap”, ownership of risky assets is usually transferred as well as related tasks, obligations and risks.
When transferring company shares (majorities as well as total shares), the management tasks or duties are usually transferred to the new owner. Thus, in the course of a “subordinated risk swap”, it is theoretically possible to hedge the entire risk from entrepreneurial activity or to transfer it to a third party.
structure
A “Subordinated Risk Swap” takes the form of a structured option transaction. In addition to the features of an option described above, it also shows the type of swap, the type of option, the option period and the option price. Special forms are possible, but always have the named characteristics.
“Subordinated Risk Swaps” are financial instruments traded over the counter and are currently not subject to any supervision or international or national regulations.
There are internationally established standardized forms of such a business that are specified by the association of market participants or its members.
Types of swap
Simple option
The “simple option” certifies the right of the option holder to sell the underlying asset to the writer at the conditions stipulated in the option contract ( put ).
Double option
The “double option” certifies both the right of the option holder to sell the underlying asset to the writer at the conditions stipulated in the option contract (put) and the right of the writer to purchase the underlying asset from the option holder in accordance with the conditions stipulated in the option contract ( call ).
Triple option
If a “single option” (rarely) or a “double option” indicates a further subscription right, for example the exchange of the underlying for another financial instrument or a purchase option for another instrument for the put, this is called a “triple option”.
Option types
Option types deal with the option period or term. However, “subordinated risk swaps” are often structured without a term or for an unlimited period.
European option
The option type of the “European option” describes the exercise of the option at the end of the term, ie at the earliest after the expiry of the option period defined in the option contract (rarely used with “subordinated risk swaps”).
American option
The "American option" certifies the right to exercise for the entire term of the option contract. This is the most expedient and therefore common variant for a “subordinated risk swap”.
Bermuda option
The "Bermuda option" offers the option holder the right to exercise the option only at one or more (possibly also as periods) specified times during the term of the option contract.
Knockout
Options and option contracts do not normally have any knock-out times or criteria, such as B. for comparison knock-out certificates, however, in the case of a “subordinated risk swap”, natural criteria and times of expiry or nullity of the option contract arise. So z. B. on expiry of the option period or the legal " loss of a thing" related to the base value.
meaning
The insurance of insolvency was risks to the invention of the "Subordinated Risk Swap" only in the hands and in favor or for the protection of creditors and creditors' interests. The instruments commonly used for this are supplier insurance , credit default insurance or, in some cases, management insurance and, in individual cases, debt-to-equity swaps. Providers are insurers and banks who spread and syndicate the risks arising from insurance contracts in the course of diversification and in accordance with portfolio theory ; in the case of debt-to-equity swaps, the issuers of an underlying bond. With the use of “subordinated risk swaps” it is now possible, above all, for entrepreneurs to protect themselves against entrepreneurial risks, especially against insolvency. Related legal disputes are often lengthy and cost-intensive and require specialist legal knowledge.
Risks associated with entrepreneurial activity can be hedged and psychological and material hurdles and obstacles to entrepreneurship are removed or entrepreneurship is promoted. Economic failure, insolvency, existential or existential threats to legal action and the associated liabilities become manageable and affordable for the individual or individual interest group.
risk
Issuer risk
Since the “subordinated risk swap” is a swap transaction without any payment obligation on the part of the issuer , the issuer risk only exists with regard to the obligation to perform . However, because in the usual cases the payment obligation or the cost burden of the service (assumption of the base value) lies with the option holder, the default of the issuer is completely irrelevant for the performance obligation towards the option holder. The service or burden of handling and coping with the assumed risks no longer affects the option holder after exercise and is therefore successfully secured because it has been sold.
Other risks
The actual risks - in particular from liabilities and liabilities with the writer - are usually administered and handled in special purpose vehicles.
Legal issues
Critics of the “subordinated risk swaps” see emerging risks in the possible lack of willingness on the part of the option holder to counter business risks adequately and with the necessary care after the transaction has been concluded. The risk of willful and deliberate damage to partner companies, suppliers, customers and creditors as a result of the use of the hedging instruments is also seen. Intentional and deliberate harmful behavior is subject to the applicable criminal law and is not protected by the use of “subordinated risk swaps”.
Repo option as a special form
A special form of "Subordinated Risk Swap" is the so-called "repo option". This term refers to the combination of a "repo" ( repurchase agreement , English sale and repurchase agreement ) and an option . This is a “triple option” in which the underlying asset can be bought back - possibly for a limited period - or at least such a buyback is securitized.
Option price
In contrast to the classic option (subscription right to shares, bonds and other financial instruments), the option price for a “subordinated risk swap” is calculated and results from the costs directly related to the individual case for assuming the risks of the underlying asset by the writer Usually stipulated by this.
Issuers
The providers and issuers of “subordinated risk swaps” are specialist institutions and companies, hedge funds and their special purpose vehicles . The market for “subordinated risk swaps” is enormous on the demand side, but is characterized by a very small number of providers on the supply side.
swell
- John C. Hull: Options, Futures and Other Derivatives ; 2011
- John C. Hull: Risk Management and Financial Institutions ; 2012
- Manuel Breuer: Evolution of Hedging Risks ; 2010
- Igor Uszczapowski: Understanding Options and Futures: Fundamentals and New Developments ; 2012