Global banks finished scaling back their commodity derivatives activities in Asia some time ago: 2014 saw both Barclays and Credit Suisse wind up that part of their business in the region. But this year the regional banks have started to copy their peers in exiting the area: DBS wound up its outfit that traded palm oil, energy, and iron ore derivatives, citing the rising cost of market-making which made this unit uneconomic.
The constellation of strong corporate contacts and the local nature of the business seemed to favour regional players such as DBS but instead they found the commodities derivatives market tough going. Likewise ANZ: commodities was a key part of the Melbourne-based bank's strategic move to go beyond its homeland to become a major player in China and South-east Asia, but the enterprise foundered last year.
Three years on from recruiting a swathe of talent from Standard Chartered's commodities business – many reportedly on very generous salaries – ANZ was forced into retreat. The vast majority of the bank's recent hires have found themselves now looking for work. And the outlook for those ex-commodities bankers appears to be to look for work in a different part of the industry. Gunnar Hoest, for example, a stalwart of the region's commodities units who headed up Credit Suisse, Deutsche Bank and finally BNP Paribas' operations, left the latter to set up shop on his own.
But Standard Chartered has carried on. Asia drives the bank's global commodities business and the region is responsible for 75% of the division's revenue. As others move back, Standard Chartered has been expanding, adding LNG and petrochemicals to its product suite – both of which are in high demand from the region's refiners. Likewise a strong and diverse client set meant it was able to broker a deal for the highly illiquid paraxylene, an aromatic hydrocarbon, between a Thai refiner and an Indonesian plastics producer.
On the agricultural side it has added pulp, and now says it can manage vega and digital risk out to three years on this and most other agricultural underlyings – all of which are typically highly illiquid.
A continuing source of strength for Standard Chartered has been its precious metals business, and with its strong franchise in both India and China the UK-headquartered bank is well placed to meet all types of demand. In addition to being one of the few global banks licensed to import into China, it is also the first international firm to become a member of the Shanghai Gold Exchange. Crucially this is quoted in renminbi, giving it the potential to be the first global benchmark denominated in the Chinese currency.
As part of its precious metals product suite, Standard Chartered onboarded its Gold Plus index, a product which has already sold a $200 million chunk to a major Asia sovereign wealth fund. According to Madhav Shankar, head of commodities sales and structuring, the proprietary Gold Plus index provides a cost-effective alternative to gold exchange-traded funds (ETFs).
The Gold Plus index is simple: essentially it's a covered call product where the investor buys gold and sells calls against it, thereby benefiting from a coupon from the calls and if the gold price goes up the investor can book a capital gain. The downside is that in a rampant gold bull market the upside is capped.
According to Shankar, the Gold Plus index is an excellent competitor to gold ETFs.
"The Gold Plus index outperforms the ETF because of the income from the short-dated call options. The idea is if you are bullish for gold then you buy this product and instead of paying 40 basis points a year in fees for an ETF, this product pays you."
In addition to holders of gold such as sovereign wealth funds and central banks, Shankar says this product is also popular with private banks, who often have clients that are long gold, which they can sell calls against.
"It's an investor product that will be of interest to anyone who is long gold. It's a derivatives structure – as a sovereign wealth fund if you are long gold you have carrying costs, but you are not getting income from it. It's costing you money but if you can overlay your stock of gold you will get an outperformance. It should also be interesting to people who buy ETFs such as pension funds."
The basic principle of increasing returns by selling puts or calls versus an underlying has been the driving force behind the success of equity-based structured products across Asia. But Shankar says this structure is particularly apposite for the precious metal sector because of the high level of volatility associated with gold.
"One of the big benefits from looking at gold is that it has high volatility. All the calls related to Gold Plus are short term – typically one or two months – and volatility over this period could be as high as 18%, particularly when compared to foreign exchange-based products. In gold you get a lot of bang for your buck in the enhancement from calls."
Standard Chartered has also played a significant role in developing China's gold derivatives markets and is a market-maker in options linked to the precious metal. As is the case with many commodities contracts – such as SGX iron ore swap – gold option deals are cleared but not traded on exchange.
Given the surprise move by the People's Bank of China on August 11 last year to devalue versus the US dollar, interest in gold has increased from mainland clients looking for a hedge against further currency depreciation.
Standard Chartered was the first international bank to become a member of the gold benchmark on the Shanghai Exchange. Once a benchmark is established it's possible to financially settle against it. On the same day that the UK bank launched its market-making operation, it also traded a couple of structured products linked to gold.
"And this is something that nobody else does – clients are able to earn a higher return on their investment linked to the price performance of gold. It's all onshore and renminbi denominated, and settled against the Shanghai gold fix," says Jeremy East, Hong Kong-based head of metals trading at the firm.
"This is the first onshore deal done against the local fixing and that makes it innovative – the Shanghai Gold Exchange is very happy with it and we are now talking to a number of clients. With China's declining onshore investment returns, from around 7–8% to 2–3%, it means investors are looking for a yield pick-up and the Gold Plus index provides that."
Standard Chartered was able to innovate in illiquid markets as well as precious metals and one satisfied customer is a Thai sugar mill. It was faced with a problem: its purchases of raw sugar are made at rate determined by the Thai Cane and Sugar Corp, while its sales are at a floating, market price. The sugar mill wanted to lock in the sell rate at a premium to the TSCC prices to improve margins.
Standard Chartered's solution was for the client to accumulate the March 17 sugar futures daily at a price that is better than market: if the price goes above the barrier it knocks out and no further accumulation or settlement takes place. And as long as it doesn't knock out, the accumulated futures position is settled against the closing prices of the underlying at contract expiry.
Not only is this an example of the bank's ability to manage both digital and vega risk against an illiquid underlying, according to the end-client it is emblematic of a high level of service as part of its ongoing relationship with Standard Chartered. A spokesperson for the sugar mill says the company is very happy with the result of the accumulator and expects to repeat the trade again.
"I have dealt with a number of banks over the years but Standard Chartered consistently makes the effort to understand my business, and come up with solutions that are tailored to my needs."
Standard Chartered operates with the brand promise of being "here for good", and this year its commodities arms demonstrated the proof of this. As others step back from the market or reduce their operations, the UK-based bank has continued to operate.
The week on Risk.net, September 8-14, 2018Receive this by email