Complexity Level Of Financial Instruments
31st March 2021 (Version 4)


Introduction

Rating agencies have been assessing wide range of financing instruments with varied characteristics and intricacies. During the last few years, the Indian Capital Market has witnessed a scenario of newer and innovative financial instruments/issues being floated by the issuers. These instruments include structured bonds, asset/mortgaged backed securities, convertible/non-convertible debentures etc.

In the context of the intricacies involved in the innovative instruments, the investors may not fully understand the implications arising out of the complexity involved in such instruments. In order to inform the investor about complexity of such instruments, Acuité has categorized such instruments in three levels: Simple, Complex and Highly Complex. Acuite’ s categorisation of the instruments across the three categories is based on factors like variability of the returns to the investors, uncertainty in cash flow patterns, number of counterparties and general understanding of the instrument by the market.

It has to be understood that complexity is different from credit risk and even an instrument categorized as 'Simple' can carry high levels of risk. 

Simple Instruments

These instruments carry high degree of certainty regarding their risk-return relationships and are reasonably well understood by investors and other market players. 

Complex Instruments

These instruments typically have variable risk return profiles and understanding of these instruments among market participants is lower vis-à-vis Simple instruments.   These are mainly instruments with variable returns over time. The number of counterparties for such instruments can be more than one. 

Highly Complex Instruments

These instruments are the highest in term of complexity and the understanding of their risk profile is usually more difficult than 'Complex Instruments'. The cash-flow, return and maturity characteristics are variable in nature and often involve large number of counterparties.

Classification of Instruments Based on their Complexity

CORPORATE AND BANK-DEBT
   Simple  Complex  Highly Complex

BANK FACILITIES

ALL

-

-

FIXED DEPOSITS

FIXED RATE OF INTEREST

-

-

COMMERCIAL PAPER

FIXED RATE OF INTEREST

-

-

CORPORATE BONDS AND NON CONVERTIBLE DEBENTURES

FIXED COUPON RATE

FIXED COUPON WITH PUT/CALL OPTION.

-

FLOATING RATE LINKED TO CERTAIN BENCH MARK RATE(WITH OR WITHOUT PUT/CALL OPTION)

CONVERTIBLE DEBENTURES

-

COMPULSORILY OR OPTIONALLY CONVERTIBLE 

-

 

STRUCTURED INSTRUMENTS
   Simple Complex  Highly Complex 

STRUCTURED BONDS/NCD'S

-

BACKED BY GUARANTEE OF GOVT/GROUP COMPANY

PARTIALLY GUARANTEED BONDS/NCDs

ASSET BASED SECURITIES(ABS)

-

FIXED RATES.

FLOATING RATES.

BACKED BY SPECIFIED ESCROW OF CASH FLOWS OR FIXED DEPOSIT.

BACKED BY LINKED TO CERTAIN BENCHMARK RATES.

 

 

 

COVERED BONDS

MORTGAGE BASED SECURITIES(MBS)

-

-

MBS WITH RESET OF RATES

PASS THROUGH CERTIFICATES(PTC)

-

-

INSTRUMENTS BACKED BY ABS/MBS.

COLLATERISED DEBT OBLIGATIONS (CDO)

-

SINGLE ASSET

MULTIPLE ASSET

BONDS STRUCTURES FOR POOL FINANCING 

-

-

BONDS STRUCTURED FOR POOL FINANCING 

 

HYBRID INSTRUMENTS
  Simple Complex Highly Complex 

LOWER TIER 2 BONDS

FIXED COUPON

FIXED COUPON 
WITH FEATURES 
(SAY A PUT/CALL OPTION)

FLOATING RATE 
WITH FEATURES(SAY PUT/CALL OPTION 
,FLOORS/CAPS)

FLOATING RATE(YIELD LINKED TO BENCHMARK)

HYBRID DEBT INSTRUMENTS

-

Basel III compliant Subordinated Debt Instruments

INNOVATIVE PERPETUAL DEBT

 

UPPER TIER 2 BONDS

 

 

Basel III COMPLIANT Tier 1 instruments

OTHER HYBRID INSTRUMENTS

-

SEPARATE TRADING OF REGISTERED INTEREST 
AND PRINCIPAL SECURITIES(STRIPS)

SECURITY RECEIPTS(ISSUED BY ASSET RECONSTRUCTION COMPANIES)

 

PRINCIPAL PROTECTED MARKET LINKED DEBENTURES

EQUITY LINKED DEBENTURES

COMMODITY LINKED DEBENTURES

 

EQUITY & PREFERENCE SHARES
  Simple Complex Highly Complex 

EQUITY SHARES

EXCHANGE TRADED EQUITY SHARES

-

-

PREFERENCE SHARES

-

PLAIN VANILLA

Perpetual Non-Cumulative Preferences Shares ( PNCPS)

CUMULATIVE CONVERTIBLE PREFERENCE SHARES

 

MUTUAL FUNDS
   Simple Complex Highly Complex 

DEBT FUNDS

GILT FUNDS

FLOATING RATE FUNDS

-

MONTHLY  INCOME PLANS

LIQUID FUNDS

DEBT FUNDS

FIXED MATURITY PLANS

INTERVAL FUNDS

STRUCTURED MUTUAL FUNDS

-

CAPITAL PROTECTED FUND-STATIC HEDGE

CAPITAL PROTECTED FUND-LEVERAGED

CPPI (CONSTANT PROPORTION PORTFOLIO INSURANCE)

ARBITRAGE FUNDS

DPI (DYNAMIC PORTFOLIO INSURANCE)

MUTUAL FUNDS-EQUITY AND OTHERS

PLAIN EQUITY FUNDS

DERIVATIVE FUNDS

ART FUNDS

FUND OF FUNDS

SECTOR BASED FUNDS

INTERNATIONAL FUNDS

BALANCED FUNDS

SPECIAL SITUATION FUNDS 

GOLD FUNDS

EXCHANGE TRADED FUNDS

INDEX LINKED MUTUAL FUNDS

 

DERIVATIVES
  Simple Complex  Highly Complex

EQUITY DERIVATIVES

-

BUYING INDEX/STOCK OPTIONS(LONG POSITION)

SELLING INDEX/STOCK OPTIONS(SHORT POSITION)

INDEX/STOCK/CURRENCY FUTURES(BUYING AND SELLING)

COMMODITY DERIVATIVES

-

COMMODITY FUTURES

-

FOREIGN EXCHANGE DERIVATIVES

-

SIMPLE SINGLE CURRENCY FORWARD RATE AGREEMENT WITHOUT ANY FEATURES(CAP,COLLAR,KNOCK IN,KNOCK OUT,ETC.)

FORWARD RATE AGREEMENT WITH CUSTOMISED FEATURES

CROSS CURRENCY FORWARD RATE AGREEMENTS

CURRENCY OPTIONS

CURRENCY SWAPS

INTEREST RATE DERIVATIVES

-

-

INTEREST RATE SWAPS

CROSS CURRENCY INTEREST RATE SWAPS

CREDIT DERIVATIVES

-

CREDIT DEFAULT SWAPS-PROTECTION BUYING-SINGLE ASSET

CREDIT DEFAULT SWAPS-PROTECTION SELLING-SINGLE ASSET

CREDIT DEFAULT SWAPS-MULTI ASSET(BOTH BUYING AND SELLING)