Standard Chartered Bank (StanChart) has excelled in India's structured products market in 2007, capturing a sizeable portion of the embryonic structured notes business by offering a number of market firsts including the first volatility-linked lookback structure in the Asia-Pacific region. Not only did StanChart make extensive innovative forays into the structured notes market, but it also pioneered the evolution of long-short hedge-fund style strategies by launching India's first multi-strategy long-short product, the Benchmark Derivative Opportunities Fund.
In a year that has seen StanChart's standing as India's structured product pacesetter enhanced no end, the bank has seized a 17% (Rs2.45 billion, or US$62 million) share in the structured notes market, which is estimated to be around $300 million, as well as capturing a 9% ($133 million) share in the structured funds market, which is worth $1.5 billion.
"Structured notes have been the driving force of the Indian structured products market in 2007," says Somnath Mukherjee, product head of investment services at Standard Chartered Bank, India. "In 2006, the market was dominated by constant proportion portfolio insurance (CPPI) structures, but by the end of the year regulators allowed banks to launch structured notes platforms. The notes have simplified structured products and given investors access to more definite, saleable payout structures."
StanChart has cultivated a reputation for structured product firsts in India over the past few years. In 2004, it launched India's first CPPI product, the Benchmark CAPPs, under the discretionary portfolio platform with ETF and structured fund manager Benchmark AMC. At the end of 2006, it launched India's first CPPI mutual fund, the Optimix Dynamic Fund of Funds, which offered the investor a capital-protected, multi-manager equity exposure.
This year the bank was first in India to come out with a cliquet structure as well as a chooser option (straddle) providing investors with a positive return on the upside as well as the downside of the market benchmark performance. Most notable is the lookback structure with a payout linked to volatility, the first structure of its type in the Asia-Pacific region.
Innovation came through the cliquet structure, which StanChart created with Merrill Lynch. The structure is a Nifty-linked debenture with a 77% participation on each yearly return on the index over three years. The 100% capital-guaranteed product offers a high watermark, thus protecting the gains and giving the investor the highest level the index achieved during the tenure of the note.
The structured note platform was first introduced to India in late 2006/early 2007, when banks were able to take advantage of the arbitrage available on non-banking financial company debentures (NBFCs). StanChart was the first bank to offer these notes to investors on a third-party basis. It partnered with Citi and Merrill Lynch to offer a multitude of note structures to the market, relegating CPPI structures to the back seat.
The market-neutral lookback structure is linked to the difference between the maximum and minimum levels of the Nifty index. The three-year capital-protected structure measures Nifty levels on monthly valuation dates. Each year it will take the average of the six maximum levels and subtract it from the average of the six minimum levels. The participation rate is calculated on the difference between the maximum and the minimum levels, with an indicative participation ratio estimated at 47-50%.
"By nature a lookback product is expensive to structure, so we attempted to extract some value in order to subsidise the cost of the option," says Mukherjee. "It worked out that if we took averages instead of absolute values, the structure became cost-efficient."
There are two prevailing reasons why structured notes have trumped CPPI products to become the mainstay of the Indian market, says Mukherjee. "The structured products market has outgrown CPPI structures because they are exciting only when one can leverage, but it is forbidden to provide leverage on a mutual fund platform as well as discretionary portfolio management service platforms," says Mukherjee. "Furthermore, explaining a note structure payout to an investor is far easier than explaining a non-linear CPPI payout."
More innovation came from the Benchmark Derivative Opportunities Fund - an open-ended equity fund designed to generate returns by adopting various arbitrage and option strategies without any directional view on the equity market. The fund exploits mismatches in pricing between the cash or spot markets and the futures and options markets.
"These products move away from vanilla cash futures arbitrage to multiple arbitrage strategies that are long-short in nature," says Mukherjee. "It would not be surprising to see many leading asset managers adopting these structured funds, and it is expected that by the end of 2008 the market will be around $1 billion."
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