As compressed yields continue to force investors offshore, banks have sensed fresh opportunities for rates products that can help swap overseas investments back into local currencies. But clients are becoming more discerning about the amount they are being charged for doing rates trades.
Standard Chartered wins Interest Rate Derivatives House of the Year for working diligently with clients in order to try and bring these costs down.
Volatility in a number of Asian currencies – the Indonesian rupiah and the Malaysian ringgit being two prime examples – has remained high, placing a renewed focus on being able to deliver solutions in the most cost-effective way possible.
At the same time, uncollateralised over-the-counter derivatives transactions are set to become more expensive as banks are forced to margin for those trades that are not being funnelled through a clearing house.
The US, Canada and Japan introduced the first phase of margining in September, for large derivatives traders with more than €3 trillion ($3.4 trillion) in average aggregate notional exposure. Other jurisdictions are expected to follow next year, with smaller institutions being subjected to the rules by March.
There are a couple of things that Standard Chartered has focused on in order to reduce costs. On the legal side, the firm has worked hard to get collateral agreements in place, even when clients' attitudes or the regulatory framework stand in the way. In Asia, for example, many companies and smaller financial institutions are unfamiliar with such legal documentation and uncomfortable signing something they don't fully understand.
On the product engineering side, Standard Chartered has looked at how to redesign the structure of the traditional payoff in order to make it less capital-intensive.
More efficient capital structures and lower prices have helped the British lender win business, despite the fact that domestic banks in a number of Asian countries are not yet subject to the same capital requirements as Standard Chartered.
The bank's increasing competitiveness has certainly been welcomed by its clients. A senior manager within the investment division of a Korean-based insurer says: "Price is very important for us. I need to be able to structure products for our customers in the most competitive way possible, and that means relying on a swap bank that is able to offer good pricing.
"Standard Chartered's prices are very attractive. They offer a good level of service, too, and I often rely on their advice when I have an idea for developing a new product."
A bank in Turkey, operating under Islamic banking principles, was looking to tap the markets in Malaysia in order to capitalise on cheaper funding alternatives. In response to the client's needs, Standard Chartered arranged a complete end-to-end Islamic cross-border solution, which consisted of a private placement of Islamic bonds (known as sukuk) and hedging mechanism.
Given the volatility of Malaysian currency markets at the time, the cost of capital had the potential to be quite high. Standard Chartered had to look for a way of bringing this down, and the most effective solution was to sign a credit support annex (CSA) with the counterparty in order to lower credit risk. The only problem is that conventional CSAs are not admissible under Islamic law.
"Strictly speaking, there is no such thing as a CSA in the Islamic format, so we had to replicate the mechanism of one by developing one that was sharia compliant," says Mathieu Lépinay, head of foreign exchange, rates and credit structuring. "This was fairly complex as the documentation had to be acceptable in the different jurisdictions and from the perspective of the counterparty."
In drawing up the Islamic version of a CSA, Standard Chartered had to draw upon three specialist legal teams: one based in Malaysia; one in London specialising in Turkish law; and one in Dubai, with particular expertise in Islamic law.
As a result, the bank was able to lower the capital requirements of the five-year transaction by between 20 and 30 basis points, representing "a significant saving for the client".
It's not just in Islamic law that the deployment of CSAs poses a challenge. Many derivatives users in Asia and other emerging markets, particularly on the corporate side, have not yet got used to the idea that counterparty agreements can help rein in capital charges and therefore cheapen the derivatives trades that they do.
"It's all about providing the right solutions to clients, staying really close to them and building the trust factor," says Raghavan Rajagopalan, global head, financial markets structuring at Standard Chartered.
"Being innovative around solutions, which involves creating customised legal documentation, helps for two reasons. Firstly, it enables successful execution of the transaction through an optimal, mutually acceptable structure. Equally importantly, it sets precedents in the market that may be replicated for future situations."
Standard Chartered has also been promoting a number of techniques to improve the capital structure of its products, in order to offer more attractive prices to its customers.
Over the past 12 months, volatility in the Malaysian market has driven up the cost of doing the kinds of longer-dated interest rate trades that are used to hedge currency movements, but this hasn't deterred Standard Chartered from activity in the market. It just means the bank has had to be cleverer in how it engineers products.
A Malaysian client was looking to refinance a five-year loan with notional value of $150 million. The loan was denominated in Malaysian ringgit, but the client was looking for a more cost-effective solution than that offered by conventional Malaysian funding. The solution was to go to the US markets, but given the volatility of the local currency at the time, any cross-currency hedge introduced into the structure would have been prohibitively expensive.
"It's a negative loop for the client: either they hedge when the markets are quieter and there is less of a need to do so, or they hedge when markets have already become volatile and it costs them more," says Lépinay.
The alternative solution proposed by Standard Chartered consisted of a US dollar loan hedged with an onshore call spread between the US dollar and Malaysian ringgit. A call spread offers protection between a lower and upper strike price, with the client enjoying the upside for any movement below the lower strike. In this particular instance, the upper strike of the call spread was around 4.6 ringgit (to the US dollar) and the lower strike was the spot rate at that time. The credit risk inherent in a call spread is generally lower than that possible in a more vanilla cross-currency swap, which in turn helps reduce capital charges.
"This was a good combination of a funding and hedging strategy to get the best price to the client. The client retained the upside in case the ringgit strengthened, which it did, and the lower XVA charges allowed us to be more competitive on the hedge cost and offer a more optimal structure. It was a win-win solution," says Lépinay.
Call spreads have been a particular focus for Standard Chartered this year, given their potential for lowering the costs inherent in the bank's products.
The finance director for a financial company based in Indonesia, for whom Standard Chartered has executed a number of offshore call spreads this year (onshore call spreads are not currently allowed in the country), says price is the most important factor.
"Standard Chartered provides competitive pricing and so last year we chose them as our hedging counterparty. Even once call spreads are allowed onshore, we have no plans to change this. We trust Standard Chartered's pricing and quick response time, and think it is better than onshore banks will be able to offer," says the client.
According to Rajagopalan, doing a call spread on emerging market currencies is typically 50–75% cheaper than the cost of a more vanilla structure. The capital and credit charges are generally 20–30% lower than a cross-currency swap.
The week on Risk.net, September 8-14, 2018Receive this by email