BNP Paribas in China is well known for the cross-border solutions it offers – always a popular way for global banks to gain market share – but this year its structured products have pitted it directly against established local players.
The bank has offered products to domestic investors that eliminate the currency fluctuation risk from investing overseas and added new payoffs that boost returns when investing in offshore forex.
“The offshore market obviously remains incredibly important, but this is a market that has already matured and is waiting for new impetus to bring it to the next level,” says CG Lai, head of global markets for China at BNP Paribas. “What is interesting this year is the domestic market. This is the first year that the Chinese have taken concrete steps to do away with shadow banking and started to realise that, despite having a huge market in foreign exchange or interest rates, their market is not efficient.”
New asset management rules put forward last year – which included scrapping the implicit guarantees embedded in wealth management products and capping investments in such products to 20% of a fund’s total net asset value – appear to have had a dramatic impact on China’s structured products market. The total notional value has jumped from 6 trillion RMB to 9.4 trillion RMB ($800 billion to $1.4 trillion), according to data from the country’s central bank.
This is where BNP Paribas has been able to leverage off its global footprint and domestic franchise to bring real value to its clients.
“We have a full suite of structured products to offer the market and we are very confident that we are one of the biggest counterparties for the local banks,” says Lai. “This is because, over the years, we have built a very strong onshore franchise with one of the largest investment-banking client bases of any foreign bank.”
Such self-praise is borne out by client testimonials, with several domestic banks maintaining that the structured solutions offered by BNP Paribas really help to meet the evolving needs of their clients.
“One of the most important things for our strategy is to be able to offer as wide a range of products for clients to choose from as we can,” says the head of derivatives at one Chinese bank. “Previously, our wealth management products consisted largely of investments linked to stocks. We are now trying to provide clients with a broader selection, such as US dollar indices and commodities, so it’s very good to find a bank like BNP Paribas that can support us in this.”
An example of how the bank has been innovating is the refinements it has been making to its suite of RMB quanto investment products, which eliminate currency exposure by giving investors access to overseas assets while allowing them to settle in the home currency.
Previously, our wealth management products consisted largely of investments linked to stocks. We are now trying to provide clients with a broader selection, such as US dollar indices and commodities, so it’s very good to find a bank like BNP Paribas that can support us in this
Head of derivatives at a Chinese bank
“The payoff for this structure has evolved quite a lot since last year,” says Henry Wong, head of forex structuring at BNP Paribas. “Last year, people were just starting to understand the market and so we kept the product very simple. This year, people are better informed and are trying to use offshore investment ideas in an onshore context, while in compliance with onshore regulations.”
One of these more complex products is the EUR/USD ping-pong quanto structure, so-called because of the way in which it uses the upper and lower barriers as triggers for client payouts. If the spot rate between the euro and US dollar touches both the upper and lower boundaries over a three-month observation period, which is likely in a volatile market, the client will receive a coupon with an annual rate of 7%. If the spot rate misses that, the client will receive a coupon of just 1.5%.
The idea behind the product is that under volatile market conditions, such as those seen at the start of the year, clients stand to achieve a better yield than they would have otherwise.
“Clients are gaining more confidence about the market and how to express their view of the market using this kind of structured product,” says Wong. “We have positioned ourselves in the market to be able to offer these kinds of solutions.”
This kind of product epitomises the change in behaviour being seen in Chinese clients, which began with a clampdown on shadow-banking products, robbing investors of potential yield.
“Banks have had to move away from their simple high-yield approach and so we now need to do something more sophisticated,” says Lai. “Other foreign banks could provide this kind of service to Chinese investors, but they would only do so on a sporadic basis. For us, this is a grassroots movement – it is a franchise we’re building.”
While BNP Paribas’s competitors may have been looking at similar solutions, Lai says the French bank was able to beat its peers thanks to its established client network and by being the first-mover.
“The whole thing about China is predicting how the market is going to change, preparing everything ahead of time and grabbing that opportunity,” says Lai. “We spotted the opportunity, had the infrastructure ready and were able to move immediately. That’s the name of the game.”
Eager to hedge
Another trend that has been evident is the increasing enthusiasm among Chinese firms to hedge their currency exposure this year. While firms started moving in this direction in 2015, when China devalued the currency, this has gathered pace over the past 12 months as authorities have stepped up their warnings that firms need to do more to guard against currency risk.
“The situation today is very different from 2015, when everyone was in a confused state and scrambling around to do something about their currency positions,” says Dickson Law, head of corporate sales for Apac at BNP Paribas. “This time around, companies are basically handling the situation more rationally. Exporters may be sitting on some mark-to-market losses, but there was no rush to unwind. A lot more thought is going into the overall hedging position. Importers take advantage of the cheap swap points and enter into hedging whenever spot comes down.”
This is where BNP Paribas’s new fixed-spread rolling-currency forward comes in – said to be the first of its kind on the market. When using forwards to hedge, companies will often roll them over every three months, which works well in stable market conditions, but can be problematic once volatility enters the game, since the point at which the forward is rolled over could be subject to an unfavourable interest rate.
“Corporates understandably want to lock in the cost of hedging at the point where the market is favourable to them,” says Wong. “So instead of having clients roll the forward at the market rate that is prevailing at the time of maturity, we identify an opportunity in the market where the costs are much favourable to clients and allow them to lock in the cost of hedging at that rate. Once the existing forward expires, they can grow into the new forward at the cost that we agree at that time.”
This product is an example of how BNP Paribas has been able to successfully leverage off its global market and structuring expertise to serve the onshore Chinese market. Lai says that in a year or two, competitors could step in, but for now no one has the infrastructure in place to do it.
The bank’s strength in China has emboldened it to play a role in the development of the market there.
Flocking to fixed-income
Over the past few years, foreigners have been flocking to China’s fixed-income market. This trend was given a further boost with the launch of Bond Connect in July 2017, which allows foreigners to tap into the market without first obtaining an onshore licence. Bloomberg’s announcement in March that it would add certain classes of bonds to its global indices gave a further impetus to the trend.
However, for now, limited tools are available for investors to manage their fixed-income risk in China. The key to introducing better hedging tools is to establish a proper repo market in the country, but that is proving difficult as repo trades there tend to be done on a pledge basis, which means the bonds are loaned out to another party, but the lender retains ownership. This makes it difficult for such bonds to be rehypothecated, Lai says.
BNP Paribas is trying to bring the internationally accepted practice of title-transfer repo into the country by persuading other international banks to execute deals on this basis.
“With title transfer, you have to show the mark-to-market, which is why Chinese banks have been so reluctant to do this,” says Lai. “If we can bring foreigners in to do this and it starts to be accepted by the Chinese regulators as the model to use, then we could transform the Chinese bond market.”
While there has only been a few title-transfer repo deals done in the market so far, BNP Paribas remains confident it will pick up. A deeper and more liquid repo market would also allow the establishment of a credit default swap (CDS) market, which the government tried and failed to launch two years ago. Lai thinks that with their efforts on title-transfer repo, a CDS market could be up and running within two years.
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