Structured products house of the year: Credit Suisse

Risk Awards 2017: Bond repacks, op risk notes, LOCs – and a big reorganisation

Lawrence Fletcher, Paul Bajer, Mounir Elarchi and James Howard

Any bank can cut costs, reduce capital and consolidate if it has to; the real trick in the structured products world is doing so while retaining clients and continuing to innovate. Last year, Credit Suisse showed it can be done.

In October 2015, the bank announced a restructure to combat falling revenues and boost regulatory capital ratios. The investment banking division bore the brunt. Six departments covering equities and fixed income were consolidated into three. One of these – the solutions unit – now incorporates cross-asset structured notes, over-the-counter derivatives and financing.

"We've been adapting the solutions business to the bank's new strategy by making cost savings and consolidating in a way that is designed to achieve an attractive return on capital for the bank, and that actually works better for clients. We're already seeing significant benefits from being able to service clients across a range of asset classes on one operating platform and we expect those benefits to grow as we continue refining the business," says Eraj Shirvani, London-based global head of solutions.

This is not hot air. Credit solutions – the business segment combining structured businesses from developed markets credit and emerging markets – boasts a return on equity of more than 40% for 2016, double its 2015 figures, while also slashing 30% from annual costs. It found some of those savings by consolidating four front-office risk systems into two and cutting one of its three special-purpose vehicle (SPV) platforms.


We're radically cutting back the number of booking and risk management systems, as well as consolidating sales and support teams
Eraj Shirvani, Credit Suisse

"We analysed the systems and support infrastructure we had for each asset class – whether it was credit, equities, rates or emerging markets – and realised there was a huge amount of commonality there. As a result, we're radically cutting back the number of booking and risk management systems, as well as consolidating sales and support teams," says Shirvani.

Equity solutions is the priority for the 2017, he says, with the same plan of cutting costs and boosting performance. That is a tricky balancing act for businesses requiring both innovation and scale, as is the case for structured notes – and Credit Suisse could not afford a dip. Around 60% of the bank's issuance volume is distributed through the private bank channel in the form of structured notes. If this business started to flag, it would drag down the performance of the entire solutions segment.

It is a business already facing headwinds. On the supply side, shrinking balance sheets have reduced the appetite to issue liabilities, while rock-bottom interest rates have squashed the premium that dealers across the Street pay for the funding they do need. Issuance is also threatened by incoming total loss absorbing capital (TLAC) rules, effective from January 2019, which will compel the world's largest dealers to sell vast quantities of subordinated debt at the expense of structured notes.

Investors, meanwhile, are approaching their limits on bank risk and increasingly capping their exposure to specific names to maintain a diversified portfolio.

Argentum: a silver lining

Credit Suisse responded to these headwinds with Argentum, a specialised Luxembourg-incorporated structured note issuance platform. Clients can access Argentum to repackage a wide array of sovereign, financial and corporate bonds with tailored derivatives payoffs. Credit Suisse provides the structured payoff for each transaction in return for the cashflow of the repackaged debt and the proceeds of the notes sold off the back of each transaction.

The platform has become a bond-repackaging powerhouse since its launch in 2014. Issuance for 2016 was $1.63 billion across 76 new note issuances. Total notes outstanding on the platform stand at 287, with Credit Suisse supplying daily liquidity on each one. Combined with repack issuance from its smaller SPV (Demeter), total issuance for 2016 stands at $2.24 billion, making the bank the number-two issuer by volume, according to Bloomberg, with a 10.7% market share.

Argentum is not the only repack platform on the Street, but what sets it apart is the ability to serve both institutional and retail clients with wholly customisable investments. "The past was about payoffs and the future is about platforms - how investors can access the market efficiently," says Paul Bajer, managing director, investor products structuring, in the global markets solution business at Credit Suisse in London.

Credit Suisse is the only bank that has put its money where its mouth is here
Paul Bajer, Credit Suisse

"Credit Suisse is the only bank that has put its money where its mouth is here. We have organised ourselves by platform delivery clusters rather than payoff clusters, allowing us to aggregate all our repack volume from equities, emerging markets, credit and rates, which at any other bank would be done via a number of different platforms," he adds.

Aggregation allows for economies of scale. A repack platform running a handful of tickets a year is hamstrung by high costs related to structuring and legal documentation. Argentum's flows mean it is able to rely on template documentation and automation to drive down costs. This also reduces the minimum ticket size to a couple of million for most payoffs – a must for private bank clients.

"Private bank clients expect a certain level of service, which for us means extending some transactions which on their own might not be profitable. But what those small trades give you is access to the order flow and the ability to build critical mass. For every 10 tickets a private bank sends your way that doesn't generate any pre-tax income (PTI), there will be one or two that generate a huge amount of PTI that you wouldn't have got otherwise," says Bajer.

Credit Suisse has leveraged Argentum to raise funding for its own operations too, in a format that protects it from the onerous regulatory haircuts imposed by Basel's liquidity coverage ratio (LCR). Here, Argentum issues notes to retail investors through Credit Suisse's private bank, which then lends the cash proceeds to the investment bank via a repo agreement struck at the same maturity as that of the notes. The bank posts less-liquid assets, which receive punitive treatment under the LCR, as collateral for this repo.

Investors gain exposure to Credit Suisse at a higher rate than that paid on the bank's vanilla secured debt, while the investment bank uses the cash to buy high-quality liquid assets to boost its LCR. Even better, Credit Suisse can treat these cash proceeds as retail deposits rather than wholesale funding, further benefiting its LCR. The bank raised $1.1 billion in funding through this channel in 2016.

"Where we have an advantage is that because we have a cross-asset global markets business and a private bank that is a great internal client, we are able to aggregate our funding demand across a huge range of businesses and asset classes, and then leverage a single delivery mechanism to raise that funding," says Bajer.

Structured credit expertise

Credit Suisse has also demonstrated its structured credit expertise in the institutional space. European insurers have been drawn to the bank by its strong offering in hybrid credit-linked notes (CLNs). The products stack Credit Suisse issuer risk with sovereign credit-default swap (CDS) exposure, offering investors a bumper coupon.

A revision of European Union insurance regulation, published in early 2015, was a game-changer for this market. The new rules set the capital requirement for spread risk on European sovereign CDSs to zero, bringing their treatment in line with that of the cash product. At a stroke, this made hybrid CLNs an attractive investment.

Credit Suisse issued a series of large notes off the back of this regulatory release, including a €235 million investment referencing French sovereign CDSs with a payoff linked to the euro constant maturity swap rate.

Beyond structured notes, Credit Suisse made a splash this year by becoming the first issuer to transfer its operational risk exposures into the capital markets through an insurance-linked security (ILS).

The ILS industry has been crying out for diversification and by issuing an operational risk bond… Credit Suisse has benefited the market
Luca Albertini, Leadenhall Capital Partners

The Swiss bank structured an SPV linked to a Sfr270 million insurance policy held by Credit Suisse and underwritten by Zurich. This SPV then issued Sfr220 million of five-year notes to capital market participants, with Credit Suisse International acting as the placement agent and Zurich retaining the remaining Sfr50 million. Investors face loss of principal if the Swiss bank suffers a minimum of two operational risk losses that result in losses in excess of Sfr3.5 billion.

"This process started when we thought about how we could most effectively manage our operational risk through insurance. Using an ILS offered us a means to do so in a more efficient way than in the past. We involved Finma [the Swiss supervisor] at a very early stage so they could get comfortable with the transaction and provide analysis on how it will be treated from a regulatory capital perspective," says Antoine de Sarrau, a director in equity derivatives structuring in the global markets solutions business at Credit Suisse.

The notes were sold in two tranches – a junior tranche yielding 5.5% per annum and a senior tranche yielding 4.5%. Credit Suisse took care to ensure the structure mimicked the features of a traditional catastrophe bond, used by insurers to cover their exposure to specific natural perils, in order to tempt established institutional investors. Buyers were not disappointed.

"The ILS industry has been crying out for diversification and by issuing an operational risk bond, when they could have insured their exposure in another way, Credit Suisse has benefited the market. Since the launch, a number of other banks have called to discuss potential op risk bonds of their own," says Luca Albertini, London-based chief executive officer at Leadenhall Capital Partners, an ILS manager.

Part of the appeal for Credit Suisse was the opportunity to achieve regulatory capital relief. Under the Basel Committee's advanced measurement approach (AMA), banks are theoretically able to receive a discount on their op risk capital charge of as much as 20% by buying insurance. It is understood the bank obtained some capital relief as part of its deal.

Captive insurance

Credit Suisse has also established itself as an indispensable partner of the captive insurance industry in recent years, turning a fringe business into a $2.5 billion behemoth. The bank has serviced captives out of the Caribbean since 2014, writing letters of credit (LOCs) that these insurers could draw upon to collateralise reinsurance contracts struck with large US primary carriers.

However, in late 2014, the market was rocked by the announcement that Royal Bank of Canada would withdraw from the Caribbean in 2015, along with its huge LOC business. When specialist insurance consultant Captive Resources, based in Illinois, scrambled to find a substitute facility provider for its roster of clients, Credit Suisse stepped in.

"They spent a lot of time learning about the business and what our requirements were," says Michael Kilbane, co-chief executive officer of Captive Resources in Chicago. "We needed them to get up to speed very quickly – our first meeting was in November 2014 and we had to get things running by the first quarter of 2015. They have upsized this year, as our business has grown, issuing 19 more LOCs than in 2015 and increasing our captives' coverage to $1.6 billion," he adds.

A new challenge for the bank was handling so-called incoming LOCs from their captive clients. Entities working with Captive Resources would post these LOCs, acquired from a menagerie of US banks, to Credit Suisse, which had to work out how they could be used as collateral for their own LOCs.

"That was a new operational twist for us," says James Howard, head of credit solutions trading for Europe, the Middle East and Africa. "We worked closely with our loans operations department in New York and went into great detail through the requirements around the incoming LOCs, establishing new risk feeds and working with our credit risk management department so we could understand that collateral."

Since late 2014, Credit Suisse has grown its LOC business fourfold, establishing it as the market leader.

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