UBS has an inherent advantage when it comes to China’s growing structured products market. The bank has an unrivalled presence in the country, operating six entities, including a securities joint venture.
But UBS is not relying solely on its network – it has displayed considerable nimbleness and product innovation to tap both onshore and offshore demand. Three trades stood out during the past year, encompassing an A-share-linked structured note, a transaction that opened the door for a global client to invest in Chinese stocks, and risk premia strategies for Chinese clients.
The local presence also allows UBS to sustain its service in a fluctuating currency environment. The bank’s entities in China consist of UBS China (banking), UBS Securities (UBSS), UBS Futures, UBS Asset Management China, UBS Fund Management and UBS Corporate Management.
Access to China is crucial for offshore clients seeking exposure to the second-largest economy, and the reverse is true for Chinese clients.
“There are four directions of client demand for derivatives,” says Mingxi Fan, head of structured solutions for China at UBS. “We are the only foreign bank that can now offer all of those to clients. Our depth also allows us to offer fast execution of the trades.” The bank serves onshore clients seeking exposure to structures based on onshore underlyings, offshore Chinese clients who want exposure to offshore underlyings, offshore clients seeking exposure to onshore underlyings, and onshore clients who want exposure to offshore underlyings.
The uncertain picture surrounding the currency exchange rate has also played its part in driving business to UBS, because it can offer derivatives to meet the market changes.
The renminbi appreciated by more than 6% against the US dollar in 2017, snapping a two-year weakening trend that began in 2014 as exports slumped. In recent weeks, the currency has reversed its status from a strong performer to an underperformer, dropping 3% against the greenback. That is the worst single-month decline since Beijing started its foreign exchange market in 1994.
When the currency weakens, Chinese investors have a stronger incentive to invest overseas to diversify the risk; when the currency gets stronger, they prefer to keep more investments onshore. That is one of the reasons why the ability to offer both onshore and offshore services matters for a sustainable derivatives business in China, says Fan.
Another example of how this ability came to the fore is the way UBS served a global client seeking exposure to China. The bank designed and executed a transaction to help the client invest into China equities with financing and hedging facilities. It started with an enquiry from the global client, who wanted exposure to Chinese equities, together with favourable financing terms and currency hedging. Those requirements faced some difficulties as the client lacked a credit line, which meant providing financing or hedging tools was a challenge.
“We came up with a solution by providing a net recourse financing tool for the client to invest into China,” says Fan. “They invested through the direct market access mechanism. We also provided hedging through a synthetic product.”
The product proved so successful that the client’s position has grown to a few hundred million dollars. The scale has meant the client’s exposure is now profitable.
Last year, UBS also launched the first A-share-linked structured note in China through its securities joint venture, UBSS. The bank owns a 25% stake in the securities firm, which is one of only two to have been given a proprietary trading licence. Through UBSS, the Swiss bank can offer local derivatives products, making it the only non-Chinese securities firm to offer local derivatives in China. In May this year, UBS applied to the China Securities Regulatory Commission to increase its stake to 51%.
There are two ways to conduct the A-share-linked business, says Fan. One is through the local swaps set up under the aegis of the Securities Association of China, the domestic equivalent of the International Swaps and Derivatives Association. The other model is that of structured products or structured notes. UBS offers these products, though the structured notes business is not as developed in China as elsewhere. The bank provides a variety of structures, such as calls, call spreads, puts, reverse convertibles, bearish autocallables and digital options. It also deals in A-share single-stock options, and has provided onshore clients with exposure to offshore commodity indexes, the Hang Seng Index and Hong Kong single stocks.
UBS has also stepped in to tap money managers’ growing interest in risk premia strategies. Risk premia attempts to isolate factors such as carry, momentum and volatility over price and across asset classes, and feed them into an algorithm that selects which assets to buy or sell.
The bank closed two such transactions over the past 12 months and more are in the offing, says Fan. The first transaction was for a bank’s proprietary desk, while the other one was for a fund manager that was trialling a risk premia strategy. UBS declined to name the clients.
Ping An Asset of China, the fund management arm of China’s largest insurer, Ping An, said last month that UBS was one of the index suppliers for its maiden risk premia strategy.