Issuer Hedging & Risk Management

The Issuer's Problem

When a bank issues a structured product, it takes on an obligation to pay you based on the product's terms. If Siemens stock rises 50%, the issuer owes you that gain. If it falls below the barrier, they must deliver shares. Without hedging, the issuer would be taking massive directional bets. Instead, they hedge—using your invested capital to buy assets that offset their obligations.

The Hedging Principle

The issuer's goal is to be market-neutral. Whatever they owe you, they want to own assets that will cover that obligation exactly. Your investment = Issuer's hedge funding When you invest €10,000 in a certificate, the issuer doesn't pocket €10,000 and hope for the best. They immediately deploy that capital into hedging positions.

Hedging by Product Type

Delta Hedging in Practice

Delta measures how much the product's value changes per €1 move in the underlying. The issuer maintains a hedge portfolio with matching delta. Example: You buy €100,000 of a Bonus-Zertifikat with delta = 0.85 • Issuer's obligation moves €85 for every €100 move in the stock • Issuer buys €85,000 worth of the underlying stock • If stock rises €10, issuer's stock position gains €8,500—covering what they owe you

Dynamic Hedging

• Delta changes as the underlying moves and time passes
• Issuer must rebalance the hedge continuously
• Near barriers or strikes, delta can change rapidly (high gamma)
• More rebalancing = higher hedging costs = wider spreads for you

Where Your Money Goes

When you invest €10,000 in a certificate: 1. Hedge assets (~95-98%) – Stock, options, futures to cover the payoff 2. Hedging reserve (~1-2%) – Buffer for rebalancing costs and slippage 3. Issuer margin (~1-3%) – The bank's profit The issuer is essentially a structured product factory—packaging hedges into retail-friendly wrappers.

Hedge Instruments Used

Hedging Costs and Your Returns

Hedging isn't free. Costs include: • Bid-ask spreads on hedge instruments • Transaction costs from rebalancing • Financing costs for leveraged positions • Slippage during volatile markets These costs are embedded in the product's pricing. A certificate with frequent rebalancing needs (high gamma) will have worse terms than a simple tracker.

Why This Matters to You

• Complex products cost more – More hedging = wider spreads
• Barriers create risk – Near barriers, hedging becomes expensive and imprecise
• Issuer credit risk – If the bank fails, your hedge assets may not protect you
• Early redemption – Unwinding hedges early can be costly (reflected in exit price)

The Redemption Process

At maturity, the issuer unwinds the hedge to fulfill your redemption: Cash settlement: Issuer sells hedge assets, pays you the proceeds Physical delivery: Issuer transfers the hedged shares to you If hedging was perfect, the assets exactly cover what's owed. In practice, small mismatches ("hedge slippage") are absorbed by the issuer's margin.

Hedging Complexity