Deal of the Year

RBS retail restructuring

The Royal Bank of Scotland (RBS) has a large team of structurers in Asia, often generating white-label instruments for clients. Shane Edwards, global head of structuring for equity and investment products, and Garry Frenklah, head of South Asia sales for equity derivatives, pride themselves on their partnerships and work as solutions providers for distributors. 

This has been exemplified by the raft of retail structured products carried out by the bank using its Alpha Centurion indexes as an underlying, including a ground-breaking restructuring in Malaysia. Back-testing on the Alpha Centurion yields a return of 327% between January 1997 and mid-2009. Notably, it performs well in difficult markets such as the Asian financial crisis, around September 11, 2001 and during the current crisis. Over the past 10 years volatility for this product has clocked in at about 6.5% per annum for the European version and 8.3% for the Asian one. Volatility for MSCI World over the past year has been 33.5%. “This strategy has been a refuge for investors from the wild swings and uncertainties we have seen in the equity markets,” says Edwards.

Alpha Centurion is a quantitative trading strategy index based on mean reversion. There is an expectation that when the price of a security rises or falls sharply, it is likely to revert back to its average price. Developed in Asia and Europe, the strategy uses a customised Asia index featuring 100 Asian stocks including Japan, all actively traded and highly capitalised – meaning there is the ability to go long/short, but not expensively. The majority of mainland Chinese shares are excluded because of their tendency to move strongly in one direction and not revert to the mean.

Every week until maturity, the 15 best performing stocks of the previous week are sold and the 15 worst performing stocks are bought. The strategy can also be applied to sharia-compliant stocks. The index has five filters and is calculated independently by rating agency Standard & Poor’s. It has been packaged in note, swap and option formats, structured deposits, insurance policies, private placement notes, OTC institutional trades, and in conventional and Islamic forms. Retail, institutional and high-net-worth clients have bought it in 100% capital protected, partially protected and non-protected forms. Typically, options on the strategy also use a risk-adjustment mechanism where the exposure is adjusted on a daily basis, based on the volatility of the strategy. This feature is similar to a constant proportion portfolio insurance technique, but with the benefit that once it deleverages it can releverage.

Structures based on the Alpha Centurion have been launched in Hong Kong, China, Singapore, Indonesia and Japan. But an area of note is Malaysia, where the mass retail restructuring took place (Asia Risk, September 2008). Dealers had flocked to Malaysia in 2007 and 2008 to provide structured products in seemingly liberal new-frontier markets characterised by large pools of personal savings in Asia’s largest Islamic finance market. But many structures failed to perform, notably those that referenced the Chinese equity market, which fell sharply last year. As a result, investors were left holding zero-coupon bonds worth less than the capital they invested upfront.

Public Bank had sold its clients one such product called Orient Express, provided by HSBC. This was an 18-month capital-protected structured deposit that contained an option component linked to a worst-of daily range-accrual on a basket of four Chinese stocks. RBS stepped in to restructure the deal for more than 700 investors, something Frenklah believes had never been done before for retail in Asia. “Usually people only pay attention to restructuring for corporates and institutions,” he says. Edwards adds: “You would have to be mad to try it, given the amount of admin involved, but we pulled it off and, in doing so, helped our client and their investors.” 

Malaysian investors invested more than RM200 million ($58.5 million) in the deposits. Any exit needed to be fungible. Public Bank opted to buy a three-year, at-the-money European call on the Alpha Centurion Index to include in the structured deposit. Investors also benefited from the risk-adjustment mechanism, giving them a responsive level of leverage. Many senior equity derivatives executives say it is almost impossible to restructure other counterparties’ trades, as book positions at different dealers are markedly different, so it is hard to offer more attractive pricing terms than those offered by the originating dealer. According to Frenklah, HSBC did not formally bid to restructure the trade.

RBS’s solution to the fungibility issue was to pay a day-one rebate to new investors at the point of purchase – though this cost was covered by a like-for-like reduction in Public Bank’s fees. Existing investors received no such benefit, but were able to roll over at par despite their mark-to-market being lower, typically 95–97%. The Alpha Centurion issue raised over RM280 million for Public Bank in June – 75% from new money and the rest from restructuring. The strategy is performing well, with the underlying index appreciating 15.9% in the 12 months to October 8, with a volatility of 7.7% per annum.