13 Sep 2012, Richard Jory, Structured Products
By May 2012, Citi's multi-asset group had manufactured more than US$12 billion notional of structured products for distributors and investors in Asia, including warrants, structured investments and funds. The US bank continued to build on its strategic joint venture with Citi Private Bank from 2011 and carried on with its educational campaign across the region, while also rebalancing its customer base further towards its institutional clients.
"We were heavily in retail issuance and product innovation, and very flow orientated in the last boom market, five years ago," says Harold Kim, managing director and head of the cross-asset group, Asia-Pacific at Citi global markets in Hong Kong. "When the crisis hit and the equity flow dried up - 80% of our business was equity-based - we got through 2008 and 2009 by adapting to cross-asset. We also started to work on funds and insurance capabilities, and a much broader set of products and investors."
"In the past 12 months, we have really started to fill in the gaps," says Kim. "Last year, we were always strong on corporates and retail for funds and insurance. We have added to that lead with several monster trades in structured funds. We have continued to do insurance, with variable annuities not just in Japan, but in South Korea, Singapore and China. We have the first post-crisis structured VA in Singapore; and the first new VA deal in Japan, which is filing now and slated to come out in the third quarter."
Looking back at the last 12 months, Kim recalls a successful period: "What we have done well this year is extend the delivery of these ideas to our institutional base and really try to move our institutional business - which is a flow monster - to be much more value added."
Insurance companies in Hong Kong have approved of the bank's structured product offerings. One wealth management arm of a locally based insurance company opted for Citi's China Select Fund last October.
The choice was based on the offer of an "innovative fund solution with mainland China local expertise: Citi is the fund manager and China AMC is the sub-manager overseeing the equity position that provides ‘access' for Hong Kong retail investors to local asset management expertise," says a Hong Kong-based official at the asset manager arm.
The underlying investment exposure is up to 40% invested in Chinese onshore A-share via ‘access products' (ie. structured products) with the rest invested in offshore Chinese equities, such as H-shares. There is daily liquidity to buy and sell at the net asset value and no lock-up period, which compares favourably with monthly dealing of most of the Chinese equity fund with A-share exposure in the Hong Kong market.
While Citi has been developing structured funds as well as catering to institutional clients, it is the balance of priorities that continues to evolve. "At the end of 2011, when I did the business plan, our production in the structured space has been very consistent," says Kim. "The business mix is completely different, but our revenue has been maintained: it was 85% equity in 2007, but this was less than 40% more recently. We have extended our commodities business (admittedly from a low base), continued to expand a large presence in foreign exchange, and increased our rates business, which was already reasonably large [pre-crisis]."
The extending of commodities structured products includes a notable success in India, where the bank issued commodity-linked debentures. According to Kim, Citi is the only bank in the country that has been involved in commodity-linked debentures since it started at the end of 2011, with products sold to corporate as well as retail investors. Multiple tranches have been sold, with gold far and away the most popular underlying. "India emphasises our geographic breadth; I don't think anyone is as active there," says Kim.
"The ability to do derivatives business in India is highly restrictive," Kim continues. A long time leader in the equity-linked debenture market in India since its inception, Kim explains "the innovation is that last year we launched a product linked to a non-equity underlying. It was quite popular because Indians love gold."
There are different levels of innovation and Citi has extended its range of thought, research and activity to meet the needs of a broader array of investors. "For some clients, showing them a multi-asset index product is interesting; for those that have seen that, showing them some sort of asset allocation approach is interesting. A moderately sophisticated client might use a means variance asset allocation approach; producing an index for that is interesting."
Maintaining its breadth of thought, the bank embarked on academic research to show the shortcomings of mean variance optimisation, especially in crisis situations. "We have developed a few different optimisation approaches to asset allocation that are more dynamic towards risk, so they react quicker when risk gets to unacceptable levels," says Kim.
The bank has three different approaches, but the common element is that they are all very reactive to risk. These include robust optimisation, tail risk hedging and the more sophisticated multi-period stochastic dynamic programming. Indexes are then developed, including one called Octave that the bank used successfully in Singapore.
The academic and educational initiative extends to warrants seminars in Hong Kong and Australia; a retail (and now also institutional) structured products event in Macau in May; and events for sovereign wealth funds and government pensions funds (including the Brunei public sector), also in May. Meanwhile, the bank teamed up with a Taiwan pension fund association for a full-day seminar in June; conducted a training and educational session in London that included Asia in May; and held a half-day session in Japan in July.
"I recently co-hosted an informative workshop with Citi," says Jennifer Wang, distinguished chair professor and associate dean at the National Cheng-Chi University's College of Commerce, and president of Taiwan's Pension Fund Association. "In this event, Citi openly discussed their regional and global experience in pension fund management and innovative annuity products."
"Their specialists had a strong grasp across products as well as markets and regulatory developments, stemming from their cross-franchise team covering structuring, financial engineering, pensions services and corporate solutions," says Wang. "Citi are undoubtedly passionate about driving the market and providing solutions for investors. They show particular strength in providing comprehensive solutions - they are unique in that respect."
Adopting this model has also paid dividends in South Korea. "Citi has been our counterparty for thought leadership on market research, innovative product idea generation and pricing flexibility," says the deputy general manager in the trust department of a Korean bank. "Citi has offered various training seminars on commodities and forex - both onshore and offshore - in seminars over the past year where we learned many product concepts and learned in-depth about these assets, which were non-traditional for our retail investors."
The Korean executive reveals Citi was hard at work last year: "We were also invited to a Singapore trading room to see how positions were held and hedged in the market. On the product level, Citi has helped us as a leading product provider on commodity products for derivatives-linked securities issuance in 2011. Citi has a lead in pricing, execution and back up research for outlooks and trade ideas. We have also reviewed alpha-generating product ideas.
Starting from the most basic of products, Citi extended its warrants business in Australia and Hong Kong. While offering an avenue for the recycling of risk, warrants have also presented a good way to develop Citi's market presence, particularly in Australia. "When there is a crisis and people lose money in fancy, exotic things they don't understand, they return to simple products they do understand," says Kim.
Citi is not the biggest warrants player in the region, but its ambitions were highlighted when it transferred a senior banker from Europe to spearhead the drive, which so far has included local seminars and a closer partnership with its consumer bank.
Kim claims the bank is a clear market leader in Australia, with a 60% share. The product set in Australia was extended to include the launch of GSL Minis and Instalment Minis. "We are the leading innovator, whether Minis or variants of Minis, taking over the leadership in Minis from Royal Bank of Scotland."
"In Australia, the changing environment in superannuation and self-managed investments means that more investors will do it themselves rather than go through traditional corporate or government pension entities," Kim explains. "The warrant issuing vehicle and the product is so well understood that extending it from instalment warrants on stock or baskets or indexes to a richer set of investment products is an easy jump." In line with this, the bank has embarked on a two-year project moving from a leveraged equity product to a broader structured product delivery mechanism. "The first step is to make sure we are the leader there."
A prominent Australian wealth management firm gives 90% of its structured products business to Citi and UBS. "Both have massively outperformed on pricing, customer service and innovation," says a member of the sales team at the firm. "We have sent Citi a number of index reverse convertibles and looked at their commodities ‘roll optimisation' product."
In Hong Kong, Citi took the opportunity to expand its warrants business when Macquarie derisked a year ago and RBS drastically reduced the size of its equities business. The bank entered the CBBC market in Hong Kong and provided educational seminars to warrants ‘novices' in conjunction with the consumer bank and other strategic broker partners.
Citi also continued to develop structured flow across the region. "We were dominant in 2007, but in the last year, it is a smaller part of what is important to us," says Kim. "We transact structured flow in every country in Asia, including Indonesia, Thailand, Malaysia and the Philippines, in addition to the larger markets - I don't think anyone else can say that." Equities remain important for the bank's relations with its investor base and for innovation.
Continuing an investment in front-to-back office systems to improve efficiency but also to better enable structured flow so that volume can be higher and spreads tighter, the bank continued to make the best use of the partnership with its private bank, where it was able to target structured flow as well as strategies.
These strategies have included a selection incorporating risk mitigation. "In the last couple of years, based on research and our product agenda, we have focused on developing risk mitigation strategies, and then how these are integrated into better asset allocation," says Kim. "It can be as simple as buying an option and embedding it. We have explored more cost-effective ways to do that: a simple extension is some target volatility or risk control approach. For example, we have done several insurance products with these."
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