Equity Derivatives House of the Year: JP Morgan

Asia Risk Awards 2011

William Lee, JP Morgan

JP Morgan has built on its firm foundations – a consistent business model, team stability and a strong balance sheet – to take its already strong equity derivatives business to a new level during the past year. The US bank now has some of the highest revenues for equity derivatives in the region, with research consultancy Coalition ranking JP Morgan in the top two for product revenue in Asia-Pacific throughout the past couple of years. This year, meanwhile, the division claims to have already comfortably hit its budget by August.

Many of the banks in this year’s beauty parade, and indeed a good number of past winners, have built their businesses largely around Asia’s vast private wealth pool. This business line, once huge, has stuttered somewhat since the crisis, and questions remain whether it will return to pre-2008 levels. JP Morgan has demonstrated it is not reliant on this area, but has significantly grown its flow business – a traditionally weaker area for the firm – with measured IT investments that have paid dividends in terms of effectiveness, and freeing up its sales staff to leverage its strengths: high-level relationships, and balance sheet- and solutions-driven business.

“The business model has been very consistent and has proven that it works,” says William Lee, head of equity derivatives for Asia-Pacific at JP Morgan in Hong Kong. “It comes down to how well we work together. We feel that our strong culture and stable team have enabled us to focus on providing tailored services to our clients and acutely managing the risk, which has been a key advantage in this market environment.”

JP Morgan’s most recent initiative, dubbed ‘Liquid Market’ internally, has broadly been an attempt to de-silo its business, and better cross-sell on established relationships. JP Morgan also hired Kazuma Naito from Goldman Sachs in June 2011 to head up sales and marketing for equity derivatives in the region to help target key areas. One of the consequences of the de-siloing has been strategically changing the country-specific sales model in Asia ex Japan – for example, instead of having a marketer focusing on institutional and retail in Taiwan, both investor types will be handled regionally. The idea is that the kinds of solutions needed to, for example, manage risk-based capital are likely to be similar for an insurer in Taiwan or in Korea.

Fund innovation
Many of JP Morgan’s most innovative deals this year have benefited from exactly this attitude to distribution. An example is a two-times leveraged fund structure referencing a variety of indexes, called the Emerging Double Bull/Bear Series. JP Morgan came up with the mechanics for the deal, while T&D Asset Management in Japan manages the structure. The tricky aspects of this deal included meeting concerns over dividend treatment, fee charges and ensuring that the leverage could be employed for each investor when they were entering the fund at different times – an unusual feature. According to JP Morgan, its infrastructure support and after-sales service meant that it was awarded the largest portion of the trade, selling close to $300 million of the deal. The fund featured a self-managing system directly embedded to generate the leverage, and the series was available in both long and short forms. Subsequently, JP Morgan adapted the product for the Korean market.

Another successful trade for JP Morgan was a solution for a Hong Kong insurance company that was interested in trading exchange-traded funds (ETFs), but was concerned about liquidity. As an alternative, JP Morgan put together a delta one certificate on the same underlying, which has similar mechanics without the liquidity issues. The firm then sold the same idea to other insurers throughout the region. “The problem is a client-type issue, not a geographical one,” says Greg Yu, head of equity and fund derivatives structuring for Asia-Pacific at JP Morgan in Hong Kong.

JP Morgan has also built up a range of new technology to better gather and share information about the market and clients internally. The firm’s ‘Shift Analyser’ automatically collects data related to the dealer’s trading aggressiveness – what price JP Morgan offered for a trade, compared with the price the trade was ultimately agreed at, if the transaction was scooped by a competitor. “When we have all the information we can see it as a capital allocation tool – you can start to see what margin I need to build into a product to make sales. If I lower my margin maybe I will get another layer of trades – then you ask yourself if that layer of trade is still marginally profitable? It has a profound implication for our risk management – it drives our internal discussion between sales and marketing on where we should be more aggressive,” says Lee.

“Clients give feedback to other banks, but a lot of that info just sits in emails. Harvesting it into a trading risk picture is hard to do, and unless your sales front-end and your trading front-end are connected together it’s impossible,” says Naito. If JP Morgan notices a competitor is being overly aggressive, Shift Analyser can help the dealer to avoid competing with them. JP Morgan bankers also say in the current volatile market environment lots of dealers have stepped back on their pricing, which lets JP Morgan question whether it should challenge for more volume. “Our value proposition is that we will show consistent pricing and suggest derivative overlays only when they make sense,” adds Naito. “Competing based on just price is not sustainable, especially in tougher markets.”

In addition, JP Morgan has also developed a system called ‘Stix’, which gathers information on clients’ extant trades with competitors for its solutions business. This means that if the client has a product that is expiring soon, JP Morgan can proactively step in with a replacement solution.

JP Morgan’s Autoquote, an email-based system developed in 2008, was one of the first automatic pricing systems, with one private banker at a European house in Singapore calling JP Morgan a “pioneer”. The banker adds that comparable automated quote systems offer a similar service but JP Morgan still distinguishes itself on sales support and broadness of products.

During the past year, JP Morgan has seen an “explosion in the amount of quotes we send out, across the private banks”, says Yu. “What we see on the private bank side is an immensely compressed margin and a reduction of notional, but a threefold increase of trades versus three years ago,” he adds. The platform has more than doubled the number of clients using Autoquote during the past three years, from 22 to 47.

“As a house we’re trying to be indifferent to volume. At some other houses when they see volume pick up, they have to hire people, and we’re saying ‘no, that’s the wrong model’,” says Naito.

JP Morgan’s automation of its flow business has freed the time of its sales staff for customised solution-oriented business, services that clients are more willing to pay for and hence have higher margins. “Because we kept the headcount constant since before the crisis, and are now more efficient in terms of quotation, it allows us to free up some of the marketers to engage the customers to solve their issues, rather than wait for reverse inquiry,” says Yu.

Several of JP Morgan’s clients highlight its customised solutions, both for retail and institutional, as outstanding. For example, Leonardo Drago, chief investment officer at AL Investment Partners in Singapore, says JP Morgan’s pricing is typically among the best but what other dealers lack is JP Morgan’s after-sales service on customised products.

Branching out
Meanwhile, JP Morgan has made substantial progress developing its business in both Japan and Korea. On the institutional side, for example, JP Morgan offered multiple notes with one- to three-year tenors taking advantage of the dislocation in the forward price of the Nikkei 225 index. The notes target yield enhancement, and JP Morgan sold the trade to regional Japanese banks and some corporates. The US bank is also recycling this idea for insurance companies in Hong Kong.

Other notable trades include algo index-based trades in Korea, and a trade with Tokio Marine for an adapted risk-control delta one fund, essentially an algo trading strategy for risk management. “We see things slightly differently from some of our competitors [that] are pulling out of Japan and moving their trading desks from Japan to Hong Kong to consolidate,” says Lee.

JP Morgan’s approach to market share, however, is strongly linked with its approach to risk management. Lee estimates, for example, that JP Morgan consistently holds the third or fourth spots for retail market share in Japan, and more recently Korea, and he is happy with this ranking level.

“When you own too much market share this is usually a reflection of your risk management,” says Lee. “Our strategy is to get a fair market share on commoditised products. So we make that our bread and butter business, and divert ourselves to spending more time with clients solving their unique problems.

“Through that process, clients will be more willing to pay because we can create a win-win situation for them. In the commoditised business, if you find yourself owning 40% of the market, something is wrong.”

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