Societe Generale (SG) has an uncommon appetite for highly structured and finely tailored hedging solutions and has thrown down the gauntlet to the competition in newer product classes given zest by the slow increase of long-term rates around the globe.
The bank’s poster child this year has been the constant maturity swap (CMS) reverse convertible note. These short-term investment products, usually of one to two years in duration, typically generate a payout dependent on movements in the US dollar CMS 10-year rate. If the spot rate stays above a downside barrier over the term of the product, investors receive full return of principal plus a fixed coupon. If it dips below, then investors will see their capital depleted. Interest rate bulls, encouraged by the Federal Reserve’s increasing hawkishness, have flocked to the product class in recent months. As the notes proliferated, SG acted quickly to adapt the product to maintain its attractiveness.
“We started with a standard convertible note, similar to what you have on equities, substituting the equity for the CMS rate. Then we brought in products with autocallable features, issuer callable features, knock-outs, and extra protection on the downside – a full stable of products around the view that there would be no rates decrease in the US,” says Jerome Niddam, head of financial engineering, global markets, Asia-Pacific at SG.
Initially marketed in 2015, the notes saw an explosion of interest over the course of the past year. SG was flooded with pricing requests from distributors relaying demand from clients but fully automated processing kept it on top of customer needs. Pricing grids can be sent to each interested investor automatically, and a simple pricing tool allows SG’s salespeople to quote, trade and confirm the notes solo, without the intervention of the middle office. Trade confirmations and product documentation can also be produced in the blink of an eye.
“If we put ourselves in the shoes of our clients, they are receiving hundreds of price requests daily and on some days are trading 20–30 times or more. That means if it is complicated for them to quote or execute with a bank, they simply won’t work with them. The fact we have this price discovery and execution capability makes a huge difference to them,” says Niddam.
Over the past 18 months, SG executed more than 550 trades for a total notional of $1.9 billion across Korea, Japan, Hong Kong, Singapore, Taiwan and Australia.
The bank has made the running in the market for rate-linked stalwarts, too. In 2016, it was the largest issuer of Formosa bonds – lightly structured bonds sold in Taiwan but denominated in currencies other than the New Taiwan Dollar and favoured by yield-hungry Taiwanese insurers.
This business spawned certain spin-off benefits for the rates franchise, too. Mass issuance of Formosas has put downward pressure on long-dated US rates volatility, a dislocation that SG packaged up in a series of relative-value trades sold to US hedge funds. Offsetting their short position on rates volatility in this manner helped the bank expand its appetite for more primary issuance.
It forged ahead with its flagship Codeis smart cash alternatives, which offer investors money market-like returns with the added security of recourse to segregated pools of collateral. SG’s differentiating factor is its ability to adjust the collateral basket underpinning the notes to cater to different risk appetites. Investors hunting for yield can park their money in notes referencing mortgage- and asset-backed securities, whereas the more risk-averse can select investment grade bonds as their chosen collateral.
French renewable energy company Neoen turned to the bank in 2016 to assist with hedging the financing for the second stage of the Hornsdale Wind Farm, a 33-turbine project located in South Australia.
At the time of the transaction in May 2016, Neoen was hammering out the details of a long-term loan from SG and German bank KFW Ipex to fund the wind farm. Mindful of how rising rates could increase its repayment costs, the energy company asked SG to provide a contingent interest rate swap – essentially, a pre-hedge that would kick in if, and only if, the sponsors achieved financial close.
SG obliged, striking the contingent swap in May with an agreement that if financial close was not reached two-and-a-half months later it would automatically unwind, with Neoen exempt from any obligation to pay the mark-to-market. This allowed the company to fix the interest rate risk of the project well ahead of the financial close and freed up time to focus on the closing of the deal. SG was rewarded for carrying risk in the contingent period through an additional premium when the swap was activated. The Hornsdale financing closed in July.
“Contingent swaps are common in Europe and the US, but this is less the case in Asia-Pacific. Yet we had the agility to offer this solution thanks to our very strong knowledge of the sponsors and having been involved with stage one of the Hornsdale project in 2015,” says Samuel Henry, managing director and head of interest rates and forex derivatives corporate sales for Asia-Pacific at SG.