Structured Products Asia Awards 2016
When clients talk about Societe Generale Corporate and Investment Banking (SG CIB), even the most critical among them agree the bank is talented at bringing new fixed-income structured product ideas to the market.
In the past 12 months, SG CIB introduced some of the most popular trades of the year, giving clients in Asia exposure to US rates, while continuing to dominate Taiwan's Formosa bond market by adapting to rapidly changing regulations to bring the product to retail investors. The bank also showed how product innovation translates into balance sheet efficiency by offering clients a high-return but regulation-efficient deposit product.
"Overall their performance is really good. They always come up with new structures, and they are always the first ones to come up with new ideas. Some clients can be very selective, and Societe Generale sometimes has to price something many times before they can get a structure going, but the staff there work really hard compared to other houses," says Minako Sakai, a manager in structured products at SMBC Nikko Securities in Tokyo.
Across Asia, one of the most popular structured trades of the year has been the reverse convertible note linked to the US dollar constant maturity swap (CMS) spread. The note has a quarterly fixed coupon, and at maturity the payoff is based on where the US dollar 10-year CMS rate is. If the rate is equal to or higher than the strike then investors get their full investment principal back; if it is lower, the principal is reduced.
They always come up with new structures, and they are always the first ones to come up with new ideas
Minako Sakai, SMBC Nikko Securities
SG CIB brought the trade to the market in the summer of 2015, and since then has made 600 transactions at a value of around $1 billion notional in Hong Kong, Japan, Korea, Singapore and Taiwan.
"It was simply about looking at the situation last summer, where appetite for equities was going down and a lot of investors were expecting an interest rate hike in the US. On the back of those two constraints we came up with this reverse convertible note," says Jerome Niddam, head of financial engineering for Asia-Pacific at SG CIB in Hong Kong.
Although other banks have since entered the market and US rate expectations have wobbled following the UK referendum vote to leave the European Union, SG CIB and its clients say they are still holding firm.
"Actually, we have a very nice entry point. The beauty of the structure is that it doesn't matter what the price is in the medium term. The focus in on the end-point at maturity," says one wealth management product manager in Shanghai.
The product manager also praises SG CIB's client service: "They provide a very high-quality service. They provide the quotation quickly and have very good post-transaction services such as valuation. Everything goes really smoothly."
Some investors raised the possibility that the reverse convertible trade might struggle if US rates head south, but the bank counters that it remains popular due to investors' rate expectations, and because they are often using it to balance out their cash bond portfolios.
"I would say most investors are buying this product for diversification in the context of a portfolio of bonds. So, yes, if interest rates go down sharply these products might see some loss, but then the bond investments in the portfolio would appreciate, so this product makes a lot of sense in a portfolio," says Niddam.
Korean Arirang structures
SG CIB was also instrumental in the development of the market in Korean Arirang, which are Korean won-denominated bonds issued by foreign entities. The French bank took part in a task force organised by Korean regulators to advise on improving access to foreign entities to issue in the Arirang market, and was the first to issue a structured Arirang bond.
The 50 billion Korean won ($44.8 million) issuance consisted of zero-coupon callable bonds, with a payoff linked to the 30-year US dollar CMS spread minus the two-year spread. The structure pays 3.3% per year as long as the 30-year spread minus the two-year spread is above zero.
"We had to spend a lot of time explaining the risk associated with the product and work with local regulators to reach an appropriate level of disclosure for the investors. Then, to hedge this kind of product, you are talking about a dollar product quantoed in Korean won that is callable with potential duration changes over the life of the product. So we needed to hedge dynamically the cross-currency swap component of the dollar versus Korean won. The set-up we have with a local entity allowed us to do that more efficiently, and to be more competitive in terms of pricing," says Niddam. A product is quantoed if it settles in one currency but its underlying is denominated in another.
Much of the risk of these products is recycled to US mortgage agencies by selling them low-strike options.
"We've been trading this massively over the past three years, and we are accumulating some positions on the risk of the CMS spread reversing. We were able to design a combination of simple instruments under which Societe Generale buys a certain combination of floor and gives it to hedge fund clients at an attractive level that offsets part of the activity from these investments in Asia," says Niddam.
"We don't have any products with capacity concerns, which means our risk recycling machine is working efficiently."
Meanwhile, in Taiwan, regulations around Formosa bonds - lightly structured corporate bonds issued in Taiwan but denominated in currencies other than the new Taiwanese dollar - continued to evolve, and SG CIB continued to be the first to adapt. Last year, the bank was first to issue under the new insurance firm regulation allowing Formosa bonds to be classified as onshore investments, meaning the 45% foreign investment cap would not apply.
Then, in late 2015, the Taiwan Financial Supervisory Commission opened up the market for Formosa products to be sold to retail investors, and SG CIB was once again first on the scene. In August 2015, regulations changed to allow for investment-linked policy (ILP) Formosa bonds to be issued, and then in November further changes were made to exclude ILP from single investor limits and to allow for a longer selling period for notes following regulatory approval.
SG CIB issued $160 million of retail Formosa bonds to local banks in Taiwan to be distributed via their wealth management arms, followed by a NZ$60 million ($43.9 million) issuance of the first Formosa-linked insurance product - a zero-coupon bond in New Zealand dollars with a 3.46% return. "It opens up a new market for insurance products in Taiwan. Insurance companies in Taiwan have been looking for ways to distribute separate account products with guarantees, and although a few ways already exist in the market, they aren't easy and there are a lot of constraints in terms of ratings. This new Formosa regulation gave the opportunity to lifers in Taiwan to wrap insurance products linked to Formosa bonds. Ours was the first, and we think more similar trades will be coming up by the end of the year," says Niddam.
SG CIB also issued the largest Tier 2 subordinated Formosa yet after regulations changed in January 2016 allowing foreign financial institutions to issue subordinated debt onshore, as long as they use an entity that has previously issued senior Formosa debt. The bank issued a 20-year fixed callable note worth $500 million, and then gained a licence to underwrite Formosa bonds in Taiwan.
Smart cash solution
Elsewhere, a combination of bank regulations and low rates made it tricky for clients to find somewhere to deposit cash and receive a decent return. Under the European leverage ratio requirements, banks have to hold capital against 3% of leverage exposures - and as cash deposits generate very little fees, they are unattractive from a bank's perspective. The liquidity coverage ratio, which requires banks to have enough high-quality assets over a 30-day stress scenario, meanwhile is also more punitive for cash held for less than 30 days.
To address this problem for both the bank and clients, SG CIB introduced its so-called smart cash solution last year. Investors place their cash and can choose to have the option to redeem on a daily basis or over a longer period such as 30 or 90 days, with higher returns for the latter. The bank can then optimise the balance sheet consumption of assets being transferred to a separate vehicle domiciled in Luxembourg called CODEIS. This vehicle issues notes to investors that pay par plus accrual, which SG CIB says is usually 20 to 30 basis points higher than most deposit or money market fund investments. So far, the bank has taken in about $1 billion notional of the product in Asia, and $3.5 billion globally. "Most of these products have a redemption period that is 30 days between the time the clients want to redeem and the time we send back the cash - and in such a case, we get favourable regulatory treatment. It addresses both where to put cash, and what return clients get on the cash, because you get returns that are above most money market funds available on the Street," says Niddam.
The week on Risk.net, December 2–8, 2017Receive this by email