Structured Products Asia Awards 2016
For Chinese corporate treasurers, foreign exchange risk management used to be simple. From 2008 until 2010 the renminbi was pegged to the US dollar. After the depeg, the US dollar/renminbi rate steadily strengthened from around 6.83 to 6.05 by the start of 2014 - meaning treasurers could simply take out US dollar loans with the expectation that the renminbi would appreciate.
However that all changed in February 2014, when the People's Bank of China (PBoC) started fixing the rate higher, leading to a steady depreciation of the Chinese currency. Treasurers didn't rush to hedge their exposures at the time, preferring to wait. But when the central bank unexpectedly devalued the renminbi by 1.9% overnight on August 11, 2015, companies were suddenly turning to foreign investment banks for ideas to hedge US dollar exposures - many for the first time.
For BNP Paribas, the timing was right. The French bank had expanded its Chinese business in recent years, setting up credit limits with more than 30 onshore banks to help it offset its corporate trades. The China-focused team had also obtained extra balance sheet capacity from senior management to allow it to do more trades with Chinese corporates. This is a key requirement, as China is a non-netting jurisdiction, which means any derivatives trades are treated as gross from a capital perspective.
With onshore options trading regulations being liberalised in 2014, many corporates - including state-owned enterprises - have looked to call spread packages as an ideal liability hedge. These see a corporate buy and sell vanilla options on the same expiry but at different strikes.
"If two years ago one client did a liability hedge for US dollars, now it's more like 50 clients doing it. It's really been a year of crazy activity for Chinese corporates looking at liability hedging solutions for foreign currencies. Secondly, we've seen importers in China who have to pay in US dollars to buy supplies offshore really active in engaging in hedging activities," says Simon Lau, head of IRFX and commodity structuring for Asia ex-Japan at BNP Paribas in Hong Kong.
In China, BNP Paribas is replicating what it has done in Indonesia, where it has a sizeable presence in the corporate forex hedging market. It was there that the bank tackled a particularly thorny issue with Indonesian corporate clients, many of which have taken out loans in Singapore dollars and needed to hedge against a volatile Indonesian rupiah. The clients wanted a cheap hedge with no potential downside so they looked to call spreads where the upside was capped.
But as the rupiah has been depreciating against the Singapore dollar since 2013, often the rate may be trading above the cap by the time the corporate buys back its Singapore dollars via the bought call options, resulting in a partial hedge. The solution was to introduce a European knock-in (EKI) option feature roughly 7% above the cap. This introduces a buffer zone between the original cap and the EKI, in which the corporate can still buy Singapore dollars at the call option strike.
If spot moves up past the EKI the client only receives a subsidy, which is equal to the cap minus the strike. If spot falls below the call option strike, there is no settlement.
Given the Singapore dollar/Indonesian rupiah cross is relatively illiquid, hedging this required some legwork from BNP Paribas. The bank needed to warehouse the risk for a period while it found clients through which it could recycle the risk - for instance, hedge funds looking for relative value trades on the cross. It also looked to sell offsetting US dollar/Singapore dollar and US dollar/Indonesian rupiah options structures via private bank clients, who may be interested in accumulator or knock-out forward structures, for example.
"For the Indonesian market, corporate activities are pretty one-way as a lot of clients are looking for a similar kind of activity. If we don't have a wide network of clients, these positions very quickly accumulate and it becomes impossible for us to quote an aggressive price to serve our clients," says Lau.
The bank has also been popular with Hong Kong-based corporates looking to hedge US dollar loans. "BNP Paribas is the best in terms of pricing and prompt response. They're our number one counterparty," says a Hong Kong-based corporate treasurer.
One of the bank's most popular products is a plain vanilla cross-currency swap, where the loan is swapped for offshore renminbi. This was popular this year due to the double whammy of a weakening Chinese currency and upward pressure on US dollar interest rates. However, the forward curve of the US dollar/offshore renminbi rate made a plain vanilla cross-currency swap expensive, meaning corporates were looking for a way to cheapen the trade.
To achieve this, BNP Paribas introduced a so-called Seagull structure, which included optionality in the final exchange of notional in the cross-currency swap. As the final exchange's strike rate is set in advance, a corporate can profit if the US dollar/offshore renminbi spot rate is above the strike. The structure caps the possible upside for the client in exchange for a reduction in the offshore renminbi fixed rate the corporate pays through the life of the swap. Clients would see a cost reduction of around 1% per annum.
To protect a corporate against losses if the US dollar/offshore renminbi rate falls, the structure also includes upper and lower strikes. If the spot rate is between the upper and lower strikes, the final exchange is done at the spot rate. Losses would only begin to emerge if spot fell below the lower strike. The bank executed its first Seagull trade in the first quarter of 2016 and has executed around 10 since.
Private bank plaudits
It's not just corporate structuring that helped BNP Paribas win the award - it also gains plaudits from private banks in the region. "BNP has been proactive and flexible in many ways. They go that extra mile to help a client," says a forex specialist at one private bank.
Private banks, however, are usually sellers of volatility as a way to enhance the strike rate of a particular structure. But with the renminbi depreciation and Brexit vote creating waves in the market over the past year, BNP Paribas created a way for them to invest in volatility as an asset class.
It did this by selling a volatility swap wrapped in a warrant, executing its first trade earlier this year with a private bank in Singapore. Private banks have always been wary of the swap format because they can lose money and it requires margining, but the warrant structure solves these issues.
"Instead of having the volatility strike at say 10%, we make the strike zero in the volatility swap. The difference between zero and the 10% is the premium of the warrant. The client pays the premium upfront. Whatever the realised volatility is at the end of the trade - it will be higher than zero - the payoff will be paid back completely to our clients," says BNP Paribas' Lau.
Introducing private banks to the idea of buying volatility has two additional benefits. First, it means they are less one-directional from a volatility perspective. Second, it broadens the sources to which BNP Paribas can recycle volatility when trading with other types of clients.
Innovative asset management solutions
The bank has also been active with asset managers in onshore China. These investors want to diversify away from renminbi assets, and are viewing a possible second interest rate hike in the US as a precursor for a further rise in the US dollar. However, onshore asset managers face regulatory restrictions on their ability to trade derivatives and move money offshore.
As a solution, BNP Paribas created what it calls a bank wealth management product. This is a non-principal-protected product denominated in renminbi and linked to the return of a non-renminbi index, such as the US dollar index (DXY).
"In this way the client can still be investing in the DXY product. That gives them a return if the dollar continues to go up, which is very similar to if they were to invest in a dollar bond, for example," says Lau.
The coupon is structured as a range accrual, so every day the client accrues a small portion. The client starts to accrue 2% if the DXY appreciates by more than 2%, and will accrue an additional 2% if the DXY appreciates by 5%. It will accrue an additional 2.1% if the DXY appreciates 7%. So if the US dollar appreciates by more than 7%, the client can obtain a 6.1% coupon. Sizes of the product can range from 300 million renminbi ($45 million) to 50 million renminbi.
The bank also showed its skill at risk management during the August 2015 renminbi devaluation. It was very active in the target redemption forward market in Taiwan, where corporates have flocked to buy US dollar/renminbi-focused products in recent years. Corporates use these products to hedge, typically selling a set amount of US dollars for renminbi at a fixed level for the life of the trade - generally two years. The target redemption feature means the product knocks out as soon as a certain level of profit has been earned. If spot falls below a downside barrier, however, the corporate has to buy US dollars at an unfavourable rate - creating losses for investors and risk management headaches for banks.
BNP Paribas, however, had learned its lesson from the PBoC's 2014 devaluation, quickly rolling its forward positions on the renminbi before its peers, and recycling vega - the underlying's sensitivity to volatility - to clients. While it did lose some money on its rates positions, its profit and loss the following month was close to flat.
A year on, Taiwanese banks say BNP Paribas is still one of their key counterparties. "Their price is competitive, and they also have a quick response. They provide some good ideas, and if we need to restructure they can do it very quickly," says a trader at one local bank.
The week on Risk.net, December 2–8, 2017Receive this by email