The foreign exchange market has this year been characterised by transactions in emerging markets FX derivatives. Despite the illiquidity of the spot market, HSBC regularly trades large exotic options in emerging markets currencies with hedge funds. In western Europe, almost 50% of the bank's currency derivatives business with hedge funds is in emerging markets exotic currency derivatives.
In the past 12 months, HSBC has completed FX-linked structured products in 186 different currency pairs, and issued more than 200 new products with a total volume of $3 billion to corporate, institutional and retail investors globally. This figure represents around 10% of the currency-linked structured notes market.
HSBC is among the first banks to trade illiquid Gulf currencies. With the Kuwaiti dinar continuing to appreciate against the dollar during recent months, speculation has arisen that other Gulf currencies may be allowed to float, or at least rise to a new level against the US dollar. To exploit this situation, the bank launched its first autocallable note linked to a basket of Middle Eastern currencies: the Qatari riyal, Saudi Arabian riyal and United Arab Emirates dirham, says Vincent Craignou, London-based global head of emerging markets trading at HSBC.
The one-year note redeems at 105% of the notional value if one of the three currencies has appreciated by 1.5% or more against the US dollar. If the note redeems in the first week then the effective coupon per annum is approximately 260%. If the note redeems after six months then the effective coupon is approximately 10% per annum. If none of the currencies in the basket appreciates by 1.5% or more during the investment term then the note redeems at 100%.
Another transaction for the retail and high-net-worth market was an autocallable note that pays a high coupon if both the Turkish lira and Brazilian real appreciate against the US dollar from their initial values. An example of a transaction based on these two currencies is the three-year principal-protected Phoenix note, which provides an enhanced annual coupon if the worst performer of USD/TRY and USD/BRL fixes below a pre-defined level on the valuation date.
The note pays a coupon of 20.5% for every year if the Turkish lira and Brazilian real do not depreciate against the US dollar by more than 30% from the initial level. If on any valuation date, both the Turkish lira and Brazilian real have appreciated against the dollar, compared to the spot rate at the trade date, then the note will be redeemed early and investor receives the principal back and the FX-linked coupon for that year.
If the Turkish lira or Brazilian real has depreciated against the dollar by more than 30% from initial levels, it is still possible for the investor to receive the FX-linked coupon on the subsequent payment dates. For example, if the return is 131% for year one and 110% for year two, no coupon is paid in year one, and the investor receives a total coupon of 41% in the second year.
Having issued large volumes of currency-linked structured products on a regular basis, HSBC can provide efficient pricing and interesting investment ideas for both the institutional and retail space. "Not only are HSBC's ideas interesting and innovative, but its marketing material simplifies the selling process to private banking clients," says Guilherme Barbosa, Geneva-based emerging markets specialist in the investors solution team at Deutsche Bank in Switzerland. "The bank offers products in a wide range of currencies with highly competitive and fast pricing. The after-sales support has always been quick, which is a key factor when it comes to choosing counterparties."
HSBC has been providing hedges for corporate investors that have large spot exposure to illiquid emerging market currencies as a result of M&A activity. An example of this is a trade in Romanian lei and Hungarian forint with a Hungarian Bank earlier this year. HSBC was able to deliver the bank a guarantee hedge only 1% away from the prevailing spot rate, with 50% participation if the spot rate moves in the investor's favour over the following week.
In addition to emerging markets currencies, the bank has also completed more than $1 billion of transactions with G10 currencies of varied types of target redemption forwards contracts for the institutional market. Investors can profit from currency movements by buying or selling a currency at a rate better than the forward rate, and the trade will be redeemed when the target level of profit has been accrued. HSBC has structured best-of, worst-of features, American knockouts and increased the leverage by using strikes based on previous movements in the spot rate - a snowball structure.