Asian interest rate derivatives markets have been buffeted by the challenges created by global monetary policy tightening. Add growing international interest in Chinese bonds amid certain investment restrictions and the task ahead becomes even more complex.
Standard Chartered, with its pan-Asian network and access to liquidity, has tailored cross-border solutions and provided insights to clients that have enabled them to enhance returns, reduce costs and mitigate risks – at a time when volatility is staging a comeback and emerging markets face the threat of fund outflows.
Whether it is structured products to access China bonds, bond forwards to generate yields and duration for insurance clients, or synthetic financing to optimise the cost of funding for clients, Standard Chartered has been at the forefront. The bank’s offerings have reached clients from Sri Lanka to South Korea and it has also widened its payoff in the past 12 months.
“We have taken a pioneering role in Asia’s growth markets, tailoring superior cross-border solutions, and providing insights that allow our clients to achieve their risk management, financing and investment objectives,” says Hoe Lon Leng, head of macro trading for the Association of Southeast Asian Nations (Asean) at Standard Chartered. “Aware of the evolving needs of our clients, and the constantly shifting market and regulatory environment, we have enhanced our rates capabilities.”
Over the past year, Standard Chartered has ramped up its product suite. It is now capable of housing the risk of sophisticated payoffs such as callable dual-range accruals, callable constant maturity swap (CMS) spread floaters, quanto CMS spread products and callable cross-currency swaps. These products will place the bank in a position to offer local currency callable investment products across Asian markets.
This also boosts the bank’s structuring and analytics capabilities – the latter has come to the fore in the current environment. Clients speak highly of the bank’s insights in helping them to not only put new hedges on, but also to dynamically adjust past ones.
Take this example: a five-year cross-currency swap (US dollar Libor into Hong Kong dollar fixed) entered into by a client in 2017 was sitting on large mark-to-market gains. The gains could vanish if forwards did not materialise as expected and might go belly-up if rates suddenly started to drop. Standard Chartered analysed the client’s overall debt forex and duration mix, and proposed monetising the gains by converting the hedge into a cap on a larger notional.
The bank also extends advice to government entities. For instance, it analysed the outstanding debt of one particular sovereign institution in the region and determined optimal allocations.
As expected, the debt portfolio was predominantly a mix of local currency and dollar debt, along with some euro and yen exposure. The credit spread was wider in euro- than dollar-denominated debt, since dollar investors are more familiar with Asian names.
The entity had a few benchmark euro notes that tapped into rates that were very low. While this was attractive for interest expense and diversification, the credit spread was as wide as 40 basis points. The spread on almost neutral base rates was significant.
Standard Chartered suggested the sovereign entity swap its existing dollar-denominated bonds into euro with an overlay cross-currency swap, as opposed to simply refinancing dollar debt with euro debt.
“Such a structure helps reduce the cost and optimise the portfolio in a non-intrusive way, as schedules and other terms remain the same,” says Mathieu Lépinay, head of structuring for the Asean region and south Asia. “The method also locked in savings from currency and hedging. By doing that we showed savings could be as much as 80bp compared to a direct euro issuance.”
Such insights, along with its ability to provide access to Chinese fixed-income markets for institutional investors or smart financing cross-border financing for corporate clients, set Standard Chartered apart from competitors that were largely focused on promoting products that lessened the impact of rising rates.
$11 trillion bond market
China’s efforts to connect the more than $11 trillion bond market – the world’s third-biggest – with the international financial system has lured global investors. But, for some, who cannot access Bond Connect – the initiative allowing foreign investors to access mainland China’s bond markets through Hong Kong – Standard Chartered is one of the few banks that can grant investment entry.
“As a committed liquidity provider in RMB markets across asset classes, we continuously help shape the cross-border RMB market, and help our global customers capture the opportunities arising from the opening of China’s capital and foreign exchange markets,” says Charles Feng, head of macro trading for Greater China.
This is key as offshore demand for Chinese paper surges, with the nation’s bonds set to join the Bloomberg Barclays Global Aggregate Index from April 2019. This is the first global benchmark to include domestic Chinese debt, which will make up nearly 5.5% of the $54 trillion index once added fully.
In December 2017, Standard Chartered strategists led by Becky Liu estimated the full inclusion of China in global bond indexes could attract as much as $286 billion in passive inflows.
The signs are already there. Foreigners’ holdings of yuan-denominated, domestically traded bonds hit a record 1.35 trillion yuan ($197.48 billion) in July, according to data from the China Central Depository and Clearing Co – up from 1.30 trillion yuan in the previous month and 61% higher than a year ago.
Standard Chartered offers total return swaps and provides clients with financing against their bond portfolio in various formats. For example, when clients seek 10-year Chinese bonds, the bank provides dollar funding and swaps them into RMB. It then uses its China Interbank Bond Market licence to buy bonds directly on the market and pass the returns to clients. These types of products are important to accept the opportunities presented by the divergence of US and Chinese rates amid escalating trade tensions.
The bank also allows customers to tap into onshore cross-currency swaps to hedge risk. The flush liquidity in China means the onshore forex swap is trading at a discount to its offshore equivalent and that gives additional returns by hedging RMB bonds into USD. This kind of opportunity is very exciting for many clients.
Standard Chartered’s prowess in China extends beyond access. Its Shanghai Free Trade Zone unit has concluded several dollar synthetic-currency loan transactions with a broad set of clients. The offering helps clients raise dollar funds from the FTZ with a lower financing cost than the traditional vanilla loan by taking advantage of the RMB liquidity and basis.
Regulation and opportunity
The bank’s products straddle other major markets in the region and have been able to sidestep some regulatory constraints.
With the evolving regulatory framework asking banks to allocate larger capital to trades, banks have been forced to raise the cost of hedging. Standard Chartered worked with clients on mechanisms to reduce exposure, and thereby credit and capital charges, making hedging costs attractive for clients.
While the margin-reform regulation induced the signing of credit-support annexes with the vast majority of counterparties, most companies still continue to deal on an uncollateralised basis. Standard Chartered has worked closely with clients to work on bespoke credit-support annex (CSA), or CSA-style collateral mechanisms that provide the exposure-reducing benefits of a regular CSA while providing corporates with the flexibility of collateral posting features.
We combine our strengths in terms of balance sheet, liquidity, capital markets and bond trading to offer the best solution to our clients. With our unique connectivity to corporate and sovereign issuers, we are able to source G3 or local currency bonds, and match the needs of both investors and issuers
Mathieu Lépinay, Standard Chartered
One interesting trade has been a bespoke collateral arrangement with a forward-starting feature, so the client does not have to post collateral on an immediate basis. Standard Chartered executed $125 million of long-tenor dollar/rupee onshore swaps with a non-bank financial institution in India. The credit exposure was mitigated through a bespoke collateral arrangement.
The counterparty placed cash as collateral to cover any negative mark-to-market in a CSA-style construct through trade-specific documentation. The collateral mechanism only gets triggered on a forward-starting basis starting in the third year onwards in order to match the client’s expected cash positions. By limiting the credit exposure, the bank increased its own capacity to offer a larger quantum of hedges for longer tenors, significantly improving the all-in hedge cost for the client.
In other areas, too, the bank has leaned on its strengths to turn the evolving regulatory changes into opportunities.
In June, Standard Chartered’s leverage ratio stood at 5.9%, compared with a minimum requirement of 3.6% for the period, according to regulatory disclosure. The measure, broadly defined as a ratio of capital over total assets, is also well above the group’s expected future leverage requirement of 3.7% from 2019.
Given it holds a comfortable leverage ratio, the bank has been extremely efficient in deals that require limited risk-weighted assets, but use a lot of leverage ratio. Total return swaps and bond forwards were some deals. Transactions like these helped insurance clients in Thailand, Malaysia, Korea and Hong Kong. Such customers seek duration, yield and options to hedge their reinvestment risk. Standard Chartered offered them bond forwards where it committed to delivering an underlying bond at an agreed price at a future point in time.
“We structured bond forwards to address the specific needs of insurance companies,” says Lépinay. “We combine our strengths in terms of balance sheet, liquidity, capital markets and bond trading to offer the best solution to our clients. With our unique connectivity to corporate and sovereign issuers, we are able to source G3 or local currency bonds, and match the needs of both investors and issuers.”