Interest rate derivatives house of the year: Societe Generale

Asia Risk Awards 2017

Jerome Niddam, Societe Generale

In a football game an aggressive striker tests every opportunity, drives play forward and knows how to please the crowd. Societe Generale plays the rates market in that style: relentless and engaging in a highly competitive field.

SocGen has embraced digitalisation over the last 12 months to ensure it is keeping lean in those areas where the old technology of some rivals is looking bulky. The bank has worked hard to deliver key products that meet clients’ needs as the market environment has changed, and has sought opportunities for product innovation to break new ground.

From an investor perspective, 2016–17 was an interesting period on several counts. First, there was an upward rates movement in several markets, most interestingly for investors at the long end of the curve, creating a welcome opportunity to capture returns. There was growing investor confidence in the rates markets, while cash provided only a very limited return. Finally, uncertainty around several dynamics, including rates and currency movements, led many firms to look for effective hedges.

“SocGen has introduced many attractive investment ideas and products, and has provided great research in a timely manner,” noted one client.

Jerome Niddam, head of financial engineering for Asia-Pacific at the French bank, says: “If I had to choose one word to describe this year, I would say unpredictable. We had a flow of unanticipated events all of last year and this has kept up this year as well, with a significant impact on G10 rates expectations and the rates curve. We have been able to succeed in the rates market thanks to our capacity to adapt our offering and deliver it quickly to our clients in order to serve them in their best interest.”

SocGen has enjoyed particular success this year with its constant maturity swap (CMS) reverse convertible note. Typically taking a one- to two-year duration, the note is a short-term investment product whose payoff is contingent on movements of the US dollar CMS 10-year rate.

This year, investors were able to use this as a bet against US rates falling. Assuming the spot rate remains above the downside barrier for the instrument’s duration, investors can realise their principal plus the payment of a fixed coupon, although the investment capital will begin to fall if the rate drops below the downside barrier.

The product proved highly popular among investors who expected the US Federal Reserve to only move rates upwards. Interest in the notes was so high that SocGen decided to automate the trading chain – an initiative it completed less than six months after the first trades were executed.

This made the buying process very fast and straightforward, and it was instrumental in SocGen recording such a high level of trades: more than 550 were processed, raising in excess of $1.9 billion for the bank. Technology was key: the pricing process was all done automatically, with pricing grids – customised for clients – sent out automatically every day. No manual pricer was required to support the sales team.

“Price discovery is very important for clients when they look at a new product,” says Niddam. “We based [the product] on the US dollar rates, which they were very familiar with and which they were also able to search and view on those months.”

In addition to being first to market, the rapid provision of prices to clients enabled very smooth trading, making the new note as easy to trade as many of the firm’s other products. It also increased the speed at which they could come to terms with adjustments to the product, limiting the impact on both bank and investor.

“This year we switched to another underlying they were less familiar with, which is sterling CMS,” Niddam explains. “I think the fact we had these automation tools enabled them to get familiar with the product and this was very important for them. Once we have educated the clients on the product risk and rewards, it’s much easier, thanks to these tools, to have the power to trade very efficiently and quickly.”

The bank has also succeeded in adapting products familiar from one line of business to another, cleverly repurposing them to support clients as needed. A good example was the support it provided to the Hornsdale Wind Farm project in Australia, which required contingent interest rate hedging of its financing.

Hornsdale is a development of 105 wind turbines, providing renewable energy to be used locally and exported to the national grid. Renewable energy company Neoen, which owns 80% of the project, was in negotiations in June 2016 to get a long-term debt facility from SocGen and German financial services firm KFW Ipex for stage two (out of three in total) of the project. Neoen needed protection against a rising rates scenario if the deal completed successfully. SocGen executed a contingent interest rate swap – a structure more familiar in acquisition deals.

“The sponsor asked us to find a solution in order to pre-hedge the date between two and three months prior to close,” says Niddam. “It was very important for them to be able to lock in all of the key parameters of the project well before the deal was closed.”

Having completed the first stage, SocGen was very confident that it could achieve financial closure within the two- or three-month period. The bank executed the pre-hedge and negotiated a contingent premium at that time. If the financial closure occurred during the contingency period – roughly three months after the pre-hedge was entered into – then the pre-hedge would be automatically transferred into a standard hedge and the contingent premium added on top of the fixed rate.

“But if closure did not occur during this contingent phase, then the swap would automatically be terminated without any mark-to-market exchange. This means any loss would be borne by the bank,” says Niddam. “This was one of the first rates-contingent hedges executed in Asia-Pacific for project financing since this kind of structure is more typically used for acquisition deals.”

While the bank broke new ground in putting together this deal, it was careful to minimise its own risk. “Project-related finance is more risky in one sense, but we were comfortable with this transaction since we had already been involved in the first stage of this project,” says Niddam.

Despite the upturn in longer-term rates, returns on cash have still been disappointing, leading investors to seek alternative vehicles. SocGen succeeded in delivering yield for cash investment through its smart cash alternatives, which are provided via a special investment vehicle, known as CODEIS.

“This is a product designed to enhance the yield of cash compared to that which you would expect to get from a bank deposit,” says Niddam. “The product is designed to be simple, so that it trades like a bond structure. The price accrues interest daily, paying out overnight interest plus an attractive spread. The product can be unwound whenever the client wants.”

The product has been implemented for various currencies and across different investment time zones, with daily, monthly and quarterly versions now available.

SocGen’s differentiating factor is its capacity to change the collateral basket underpinning notes to help manage the risk appetites of different investors. If firms want a more aggressive stance, they might select mortgage- or asset-backed securities. For investors who want less risk, taking collateral from the pool of investment-grade fixed income works better.

The head of fixed income for one agricultural co-operative says: “Societe Generale is very trustworthy; it is one of the most reliable investment banks and has a credit rating that meets our needs. It has delivered brilliant investment ideas and products, especially through those structured notes issued by the bank.”

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