Low rates in Asia coupled with investors’ unquenchable thirst for yield have forced banks to look for novel ways to meet clients’ needs. Remaining steadfast in the region, Societe Generale’s credit team has stuck to the principle that has brought them such success over the past couple of years: a diversified offering across the credit spectrum.
SG’s core credit team in Asia is made up of six traders and nine product engineers, with a business that extends into nine countries in the region, responsible for notional trades of more than $5.2 billion over the past 12 months. And according to Ryan Chan, co-head of business development for the cross-structuring group in Asia, credit is becoming an even more important asset class in the region, thanks to the advent of the Basel III regulations.
“Why is credit such an important asset class within the Basel regime? Basically three things: one is the liquidity requirement, the other is the risk-based capital requirement and the third is a non-risk based capital requirement,” Chan says. “Credit financing is one of those rare asset classes that can satisfy all three.”
Furthermore, Chan says credit is an asset class that can deliver a more attractive return than other investment opportunities, including equity, because its risk-based capital requirement under equity is minimal. He also points out that, “providing the transaction is structured intelligently”, the cost of complying with other requirements – including the leverage ratio and the non-risk based capital requirement – can also be minimised. This is why credit financing trades are becoming more important to clients, he says.
One of the key achievements for the French bank over the past year has been the leveraged bond basket note, which moves away from the single name transaction Societe Generale says is favoured by its competitors.
The bank began by focusing on top tier names, such as the Bank of China and ICBC, around three years ago and progressively downgrading the stocks it included in the basket. Chan says if these stocks were used as single-name underlyings, the risk/reward ratio and the type of hedging that would be needed would not justify doing the transaction. This is one of the reasons the bank has been focusing on diversification, with baskets containing up to 60 stocks.
“This is a very effective solution for clients, providing a diversified offering and including margining on the top – similar to that which would be provided in a master agreement, even where no master agreement is in place. We also allow them to actively risk manage and change names,” says Chan.
SG says it has done a “significant amount of notional” during this period – although declined to give a specific figure – and there is still huge potential for more trades in the future to be done.
“More and more of our clients are recognising the value of our proposition rather than sticking to single-name financing that has so far been prevalent in the market. I think this is a trend that will continue,” says Chan.
Between June 2016 and June 2017, the bank executed five credit transactions underpinned with diversified baskets of stocks.
Credit-linked notes (CLNs) have been at the core of SG’s hunt for yield over the past 12 months. It has strengthened its platform with the addition of new Australian and European companies, and also introduced call and quanto options into the notes. Investment in technology has also been crucial to the bank’s success.
“Regarding technology we have a fully automated chain for execution of these trades: from pricing requests from buyers to booking the trades in our system and generating documentation for clients. We also have an online platform called Alpha Structured Product where clients are able to price and trade directly vanilla CLNs with our bank. And we have a sales pricer, which our sales teams use on a daily basis to provide a longer list of prices to clients,” says Chan.
Chan says the diversity of the bank’s product offering is reflected in its clients, who range from corporates to several different financial institutions in the space.
In addition to developing its internal infrastructure, the bank has expanded its CLN business in the region by moving into Thailand and Malaysia. SG began trading CLNs with Thai clients – predominantly asset managers – in 2016, and has so far completed around 10 trades. In Malaysia, the bank began trading first-to-default CLNs last year with a local asset manager.
When Beijing issued a slew of window guidance about transacting offshore, Societe Generale was quick to respond with a cross-border financing solution that allowed onshore clients to maintain a capital flow offshore.
The solution is simple, but effective. Clients deposit cash with SG’s China unit. The bank then uses the money it collects in this way as collateral to write them a list of credit denominated in US dollars, a currency that does not face the same restrictions as the renminbi does.
SG says it has done $200 million of this type of trade.
The other side of the bank’s credit offering focuses on risk mitigation and diversification. Risk mitigation is offered through bond repacks, which Chan says also offer yield enhancement.
“In Taiwan some local banks need higher returns so we traded with them repacks with Swiss bank bonds as underlying, which paid structured coupons based on dollar steepness. This allowed clients to take advantage of the dollar steepness yield enhancement, while at the same time also taking advantage of the market opportunity on the Swiss bank bonds,” Chan says.
Risk diversification is offered through credit indexes, which are liquid and transparent with small bid offer spreads. The bank has gone further, adding the ability to call the product and structuring coupons in order to increase yield.
The equity mezzanine tranche of this CLN has been one of the bank’s most popular products, along with correlation credit products and the hedging of corporate loans. Trading of these products places exotic risk – correlation risk, credit protection risk and recovery rate risk – on SG’s books, but the bank has been able to sell off the risk to hedge funds as super senior tranche CLNs and digital recovery credit puts.
Looking ahead, the credit team expects to see clients move to soft currency onshore credit markets, such as China, as spreads on the hard currency and offshore credit markets remain tight. This, they say, will be supported by new access routes into China. India and Indonesia are expected to be impacted by the same trend, which will eventually spread to Vietnam and Taiwan, Chan says.
Chan says: “Currently a lot of credit is held by locals, which makes markets much more stable but less liquid, and both investors [in China and Korea] are trying to find a way to diversify savings in the region. So compared with two to three years ago, we have more volumes and revenues on the non-Asia assets with Asia clients, and that’s what we are trying to do.”