Banks offering commodities structured products have over the past year focused on protection in order to shorten duration and tweak payouts after the rally in key products such as oil. This was the strategy that Societe Generale followed, while also structuring a product aimed at capturing the electronic vehicle (EV) revolution.
Rising client demand for commodities exposure through structured investments such as payouts that work in both a bullish and bearish oil market have boosted revenues and volumes, says Olivier Godin, head of commodities for Asia-Pacific at Societe Generale. Automation has also played a role, with price discovery and trade execution capacity soaring.
The lender’s financial engineers in Japan created the first proprietary index linked to the trend for EVs. The index, developed last year at the behest of a corporate client, targets a long-term investment trend and is up 4% since December.
EVs will outsell their petroleum-driven equivalents within two decades, Bloomberg New Energy Finance estimated last year. Such an event could disrupt the entire fabric of the commodities market. Societe Generale believes the coming decade will be critical for the emergence of EVs, and therefore created the index, which is designed to help avoid the pitfalls of trading illiquid metals or the volatility of investing in metals suppliers.
“EV is a very fashionable theme, but it is not at all easy to play in investing,” Godin says. “Commodities associated with the EV revolution, such as lithium and cobalt, are too illiquid for structured products, while investing in the shares or exchange-traded funds of minor metal suppliers is very name-sensitive and can exhibit a high beta with equity markets. We solved that by coming up with an index of liquid commodities in which EV will play a crucial role.”
The index tracks a basket composed of nickel, copper, aluminum, zinc, palladium and platinum. While EV demand currently makes up just 3% of nickel demand, that figure is projected to surge to a fifth in the coming years and the price of the metal will be driven by the success of EVs, according to the bank.
The bank now offers a 10-year capital-guaranteed note linked to the EV index. The note carries a 3% coupon in the first year and then a participation coupon linked to the index’s performance that year. Investors can redeem the notes, which have annual observation dates, if the index registers performance superior to 25% from the strike date.
The product adds to the list of the bank’s strategies that target movements in energy, precious metals and agri-products, and represents an extension of its commodities research strengths in the region, which encompass over-the-counter derivatives and structured solutions.
The EV product complements the bank’s other offerings, such as the Twin Win on Oil, which allows investors to benefit from moderately bearish and bullish oil scenarios. This product, which Societe Generale considers a “blockbuster”, accounted for as much as a third of all its commodities deals in the past year. It was gobbled up by private banks in Singapore and Hong Kong to protect portfolios following an oil price rally that saw Brent crude push through $80 per barrel for the first time since November 2014. This year, the bank expects oil prices to be range-bound.
“The Twin Win payoff is basically an autocall product paying coupons on early redemption,” Godin says. “If it doesn’t get knocked out, investors get a long call/long put position at expiry, in the absence of a knock-in event, in which case they receive the underlying performance.” If the product is autocalled before maturity, investors receive a coupon that could be in the double digits. If it isn’t called, they receive a long straddle option, or a long forward if the underlying has breached a downside barrier, which is usually around 60% or 70%. Under a moderately bearish or bullish scenario, therefore, investors can profit from a move in the underlying asset in either direction or a “nice fixed coupon,” he says.
In July 2017, Societe Generale also achieved success with a structure indexed to gold and silver. This product, which had a one-year maturity, offered monthly redemption with a coupon payment if both underlying prices increased. If it was knocked out, investors received the original capital investment if neither underlying registered a performance inferior to a specified barrier. Otherwise, they received the performance of the worst-performing underlying. The structure was redeemed early after just one month as both underlyings delivered positive performance, earning returns as high as 12%, Godin says.
The bank has increased the probability of early redemption across its commodities products by building in monthly and daily observation frequency. It has also introduced the so-called glider barrier, which gives investors an additional chance to redeem early.
Societe Generale also piggy-backed on its global network to cut the risk in its own books. Clients in Asia typically preferred the worst-of bullish structures, which meant the bank was short correlation. It spotted that European hedge funds were willing to buy dispersion trades to express their views on the fundamentals of underlying commodities, so, in order to avoid being loaded with one-way risk, while at the same time opening up avenues to offer competitive prices for clients, it would buy correlation to balance the books, Godin says.
Rising volumes have helped the bank expand its Asia-Pacific network, including in Japan where clients are warming to commodities structured products. The bank has also expanded its relationships with oil refiners in Thailand and private banks in Hong Kong and Singapore.