The cost of onshore hedging in Indonesia skyrocketed towards the end of 2015, as a fresh wave of volatility buffeted global currency markets and Bank Indonesia asked domestic corporates to do more to shore up their risk exposure. Yet despite this CIMB Niaga continued to grow its business, and saw its volume of foreign exchange trades double in 12 months.
To win this year's Indonesia House of the Year award, CIMB Niaga not only had to beat off aggressive competition from its domestic rivals, but also from global players that can offer more complex offshore hedging products at a much lower cost than those available onshore.
Although Bank Indonesia is slowly opening up the onshore derivatives market, it still remains fairly restrictive and many corporates continue to look overseas to meet their hedging needs. As a local bank, CIMB Niaga is not allowed to offer offshore products to Indonesian clients.
"We face stiff competition from offshore banks who can offer products such as call spreads, which are not presently allowed in the onshore market. These are much cheaper than doing a cross-currency swap," says Agung Marsubowo, a forex option trader at the bank.
A call spread combines bought and sold call options with the same expiration dates but different strike prices. Because it caps the upside as well as the downside it is generally cheaper than a simpler hedge. Bank Indonesia has plans to allow call spreads on to the domestic market, but for now any company that wants to use them has to go offshore.
However, the structure only offers partial protection, which is why CIMB Niaga has been targeting those companies looking to fully offset their risk. This means making the onshore products more affordable, says Marsubowo.
But the usual way of hedging onshore – using cross-currency forwards and swaps – can be costly.
Prices have been forced up by growing demand for hedging. This has been partly caused by Bank Indonesia further tightening up hedging requirements for corporates, which now have to hedge at least 25% of their foreign asset liabilities and maintain a minimum 70% liquidity ratio of foreign assets. Growth in foreign investment, which according to government figures grew by 19.2% in 2015, has also played its part.
As a result, the one-month onshore implied yield of the rupiah against the dollar, which is used to price forwards, hit 14% at the end of 2015. It has since come down and now stands at 6%, but this remains painful for anyone wanting to do onshore hedging.
"Even as the cost of hedging was going up, the volume of hedging that we were doing was also increasing," says Ferdinand Wawolumaya, head of trading and structuring at CIMB Niaga. "It might be expensive for companies to hedge, but it will cost a lot more if the rupiah depreciates against the dollar."
The increase in volumes speaks for itself. Between May 2014 and May 2015, CIMB Niaga booked $600 million in forex trades. A year later this had doubled, to $1.2 billion.
Winning business from other domestic banks, as well as local players, required both extensive warehousing capabilities and a strong regional network across the country.
"Foreign banks clearly have sophisticated risk management capabilities whereas large domestic banks have the regional network. We have both," says Wawolumaya.
At the start of the year, CIMB Niaga began offering a rupiah-denominated cancellable range accrual structured product, which allowed the investor to pick up extra yield. The product has a typical tenor of three years and an accrual of 9% as long as the Jakarta Interbank Offered Rate stays within a particular range. This compares favourably with the normal callable fixed rate of 7.8%.
"This product perfectly meets investor needs because it is denominated in the local currency with an attractive yield and principal protection," says Hendriono, structured and banking product head.
The key to successfully engineering the product in volatile market conditions was having the capacity to warehouse the risk in-house rather than trying to pass it on to the market, says Wawolumaya.
"If we had done a simple back-to-back, we would have lost some of the margins as counterparties usually keep a spread for sales margin and credit spread," he says. "However, if we are able to find the other side of the trade – the client to receive a fixed rate – the return to the bank can be maximised."
The bank also made clever use of market volatility to introduce delta hedging into the product.
"Since the volatility of the hedging instruments is high, capital gains generated from delta hedging can be used to offset the negative carry. From a client perspective, this allows us to offer higher-yielding structures," says Wawolumaya.
The bank aims to generate an additional 1.2% from the delta hedging, which is the difference between a standard callable fixed rate product and the rate that CIMB Niaga is able to offer.
Another way that CIMB Niaga has been able to bring more value to clients is by moving away from swaps as a way of managing US dollar interest rate risk.
"Swaps can be quite capital-intensive in terms of the credit risk capital charge. Furthermore, when we do swaps with other banks, they often impose an additional credit charge on us," says Wawolumaya. "Switching to interest rate futures reduces these capital and credit charges, and gives us more attractive pricing."
Eurodollar futures have similar characteristics to forward rate agreements and so can be used to replicate interest rate swaps, says Wawolumaya, although some additional renegotiation between broker and client has to take place.