Towards the end of 2016, two large European companies were engaged in a corporate action that resulted in an illiquid security. French banking giant Natixis was quick to spot an opportunity to monetise this illiquidity premium and within little more than two months had repackaged it into a five-year principal-protected note that was sold to the Asian market where it made most sense: the yield-starved Japanese.
“This was an innovative way of revisiting secured funding products,” says Nicolas Reille, head of equity derivative sales and financial engineering for Asia-Pacific at the bank. “We had interest from just about every major financial institution in Japan. The negative rate environment has left them starving for yield and even the classic repack solutions are not good enough to meet their needs. This was a very unique solution for them.”
The investment opportunity was repackaged into a five-year note that offered a fixed annual coupon well above current money-market rates: 20 basis points over Libor. The interest payments are made over the lifetime of the note, with the principal being returned upon maturity. The total size of the transaction was €400 million ($480 million), split evenly between Japanese and European investors. The Japanese segment was denominated in yen, allowing investors to keep to their home currency and avoid cross-currency exposure.
“From discussing with people on the market, we believe that we are the only bank to have taken advantage of this opportunity to offer it to clients,” says Julien Calas, an equity derivatives structurer at Natixis based in Tokyo. “Our previous repack and secured funding experiences were key in finding the unique way to structure the transaction, and even if others did also spot the opportunity, we are almost certainly the only player to structure it in the unique way that we did.”
Whilst the note Natixis offered to European investors was fairly straightforward, the Japanese structure had the added complication that it had to be fully collateralised.
“Drawing a parallel with CLO [collateral loan obligation] distribution in Asia, top-tier Japanese financial institutions usually have a conservative approach and mostly take triple-A tranches, whilst mezzanine and equity tranches go to investors in other countries,” says Calas. “To be consistent with this kind of risk appetite, we had to work on setting up a scheme as secured as possible but that kept yield impact to the minimum.”
Typically, Japanese investors rely on a tri-party service provider for their collateral services, but because of the illiquidity of the collateral this wasn’t possible with this transaction and so Natixis had to provide much of the collateralisation services itself.
This meant putting in place a structure to manage this collateral and making sure that all the correct legal documentation was in order (including a global netting agreement) to guard against any collateral loss. Collateral adjustments had to be made on a daily basis.
The other significant challenge to the structure was that the two Japanese investors into the note wanted to invest in very different ways. Natixis would have actually preferred to offer the structure just to a single investor in Japan, but in the end was unable to offload the entire €200 million structure to a single client.
“With clients, it’s always about negotiation,” says Reille. “We had the size and we had the scarcity, so we could be a bit more picky in terms of what we could offer the client, but if a single client had taken the full amount they would have demanded a higher yield. In the end, splitting the structure between two investors was a compromise.”
Being able to limit the investment to just two clients helped with the structuring, but it still proved challenging because of the markedly different ways in which the investors wanted to access the note. Whilst Natixis won’t give specific details of the structures – citing the need to protect the identities of the clients – Reille says the different structuring was driven by differing concerns over liquidity. Whilst one client was happy to invest in a traditional note format, the other client wanted the note in a Japanese format, which meant Natixis had to go through a local trust in order to repack this leg of the product in the way the client wanted.
“If we had had a single client the deal would have been much easier,” says Reille. “Here you have two clients which are both conservative institutions, with a very deep decision-making process, so it gets pretty complex to have to answer specific requests for each client to check that it can be accommodated.”
And on top of all this, because Natixis wanted to close its books by year-end, it had to be done in double-quick time: from identification of the opportunity to structuring of the product and closure of the deal, the time window was little more than two months.
“Just to be able to know who to talk to in a large Japanese organisation is a real challenge; this shows the quality of the connection we have with clients in Japan,” says Reille. “On top of that, we had to provide some bespoke structuring on each of the different solutions and meet the needs of the Japanese clients, who were the most demanding. Given our previous experience with secure funding and with our Japanese clients, we were able to anticipate these requirements and close the deal on time.”