House of the Year, Japan: Societe Generale

Asia Risk awards 2015: French dealer moves beyond core offering to establish a broad-based business in Tokyo

Tokyo's Marunouchi finance district became home to one more market-leading financial firm this year when Societe Generale unveiled the location of its new headquarters in Japan. It made perfect sense for the French bank to be closer to the institutions it has been successfully servicing for many years, and it also signifies how its business continues to flourish in Asia's most developed financial market.

Societe Generale has created a single sales and structuring team in Japan to offer clients even more product choice across asset classes, and the new approach has already led to an increase in client activity.

The Japan story has gained momentum ever since Prime Minister Abe returned to power in 2012, promising to revive the country from its economic torpor through a combination of monetary expansion, and fiscal and structural reform. Over the past 12 months the yen has weakened to 125 to the dollar and the Nikkei 225 is up by a further 10% after doubling over the past three years, but this has been accompanied by caution from investors as the markets are not as exuberant as they were when 'Abenomics' began.

While the continued upward trajectory of the Nikkei has had a positive impact on dealers active in equity derivatives, Societe Generale has diversified its business to protect against shocks. As an example, in the highly competitive Uridashi equity-linked autocallable market, the French lender has played a role, but with margins being squeezed it has bolstered its presence in the private placement market to create bespoke structures with juicier returns.

In the private placement market, the bank transacted ¥250 billion ($2.1 billion) in equity-linked and hybrid notes, gaining a 25% and 40% share, respectively. A typical product last year was a worst-of forex and equity product, such as real and Nikkei 225 or Stoxx 50 and real.

"Innovation for us isn't just creating a product gimmick, but pushing the right underlyings at the right time. We started using Stoxx 50 18 months ago, when the European recovery started, and over the past year emerging forex has worked well, with the yen continuing to depreciate. We expected forex forwards to be lower than where they are realising and we extracted that value," says Hideaki Takahashi, head of global markets sales, Japan at Societe Generale.

Exotic strengths

The French bank's strengths in structuring more exotic payoffs has been especially valuable over the past 12 months, as vanilla structures are paying lower yields due to low volatility and additional pressure coming from Japanese banks now selling some of these products themselves.

"Japanese securities houses have been increasingly structuring some of the simpler products in-house, but they still require foreign investment banks when it comes to exotic derivatives or complex payoffs. Societe Generale has more consistent and stable pricing than other counterparties, and the sales people are familiar with emerging market exposures," says the head of structured notes at a Japanese securities firm.

The French bank has a significant franchise serving major macro hedge funds playing the Japan market. A Hong Kong-based hedge fund manager who actively trades Nikkei options, variance swaps and volatility swaps says Societe Generale's strength lies in being a key counterparty regardless of market conditions.

"They are the best by miles in terms of quoting tight and fast on Nikkei-linked derivatives. If there's a typhoon outside or markets are more volatile, other counterparties have wider spreads but Societe Generale is always there. This is really important for us, especially when we want to unwind a good trade that's in-the-money," says the principal at the hedge fund.

Big wins in PRDC

Another area of big wins is the power-reverse dual-currency (PRDC) notes market, where investors take long-dated – 15- to 20-year – exposures to rates and forex. Societe Generale has pioneered Turkish lira and Brazilian real exposures instead of the usual US dollar and Australian dollar products, which has allowed it to shorten the duration to less than 10 years while still offering a coupon of 5–10% due to high onshore rates in those countries.

"A 7% coupon for 10 years equals 70%, so even if the currency drops by 50%, the investor is still up by 20% compared to a 10-year Japanese government bond paying 40 basis points, which equates to 4% over 10 years. Emerging market currencies are not performing well – they have dropped versus the dollar and are relatively stable versus the yen. These products are at capital-guaranteed levels unless knock-in triggers are reached," says Takahashi.

Volumes over the past 12 months for emerging market PRDCs reached $350 million, representing 10–15% of the entire market, according to Societe Generale.

Structured credit innovation

The French bank has also been active in developing innovative structured credit products, which shows its responsiveness to a market where credit spreads have significantly tightened over the year, to the point where many major companies have double-digit credit default swap spreads in contrast to triple digits a few years ago, causing yields on traditional credit-linked notes (CLN) to shrink. The firm offered clients a credit spread-triggered early call and a CLN linked to emerging market currencies, placing ¥55 billion over the Asia Risk awards period.

A further area of strength this year has been Societe Generale's increased participation in the cross-currency swaps market, where it tripled volumes to ¥1.5 trillion of business with institutional investors who want access to long-term euro and dollar liquidity.

Societe Generale has credit-support annexes in place with financial institutions, and it quantifies exposures using its XVA desk to calculate CVA and FVA risk, and to model capital requirements. Deploying its balance sheet in this area highlights the bank's appetite for longer-dated risk as cross-currency swaps act as a drag on capital under Basel III.

Societe Generale's variable annuity (VA) product is a major strength of its business in Japan. The market was hit hard post-crisis as inadequate hedging caused a number of foreign insurers, including Hartford and ING, to make an exit after incurring heavy losses. The French bank helped to reignite VAs in Japan by offloading the insurance risk through its captive reinsurer, Catalyst Re, while managing the investment elements internally. The structure uses a volatility-targeting mechanism, so losses are capped in a downturn and investors can still benefit from an upswing if the market recovers.

Societe Generale has 17 funds and counts five of the top 10 insurers as its clients. It also has a 25% share of new business, more than ¥1.2 trillion in guaranteed-minimum death-benefit products and a similar amount in guaranteed-minimum accumulation benefit products. Total assets under management exceed $10 billion.

Mitsui Sumitomo Primary Life is a leading Japanese life insurer that uses Societe Generale for reinsurance and dynamic hedging products, including notional resettable forwards on a custom index. Kazuhiro Ozeki, the firm's general manager, product group, says: "Societe Generale has a proven track record as a provider of long-term reinsurance in the Japan VA market. They have a good understanding of the challenges faced by Japanese insurance companies and always propose innovative solutions."

This success has encouraged a handful of competitors to enter the VA business over the past 18 months in a bid to erode the French bank's market share, but Societe Generale continues to innovate.

With the 10-year Japanese government bond yield plummeting to as low as 30bp, it has become harder for VA providers to pay distribution fees while still offering the product. In response, SG deployed its expertise in managing long-dated risk by creating a 20-year VA product using a bespoke investment index and keeping a tight control over hedging costs.

"We launched a product that nobody else is offering. The market is also softening from VA to fixed annuity as commissions are getting thin. We are providing solutions in both areas, making us unique in the market. It isn't easy for banks to obtain risk limits to manage lapse risk and mortality risk," says Takahashi.

Societe Generale has also made significant inroads in providing hedging solutions to corporate Japan, a key client segment that is renowned for being conservative.

Corporate clients have doubled from around 50 in 2012 to more than 100 this year. Derivatives for liability hedging purposes represent 60% of the business with Societe Generale, helping importers to hedge the weak yen with embedded forex option structures.

"We have offered both vanilla and lightly structured hedging, and this has become another pillar for us, especially with the yen continuing to weaken to the detriment of importers. Our single sales and structuring team has been able to secure more of this business," says Takahashi.