Derivatives house of the year, Japan: Societe Generale

Asia Risk Awards 2018

Arnaud Davoust
Arnaud Davoust, Societe Generale
Societe Generale

A new style of annuity product was launched on the Japanese insurance market earlier this year, supported by a custom index solution created by Societe Generale’s structuring team. The innovation has been causing quite a stir among Tokyo’s life insurers. 

“This is really the talk of the market at the moment,” says Tokyo-based Arnaud Davoust, head of financial engineering for global markets at Societe Generale in Japan. “We took part in a forum targeting insurance companies a few months ago and all the Japanese lifers represented at that forum were looking at it. I think this is likely to upend the bank insurance market in Japan.”

The French bank’s success in Japan has been built on its ability to structure finely tailored solutions for its institutional clients, especially insurers. The fixed-index annuity transaction the French bank closed with its Japanese insurance client in August this year falls into that category.

“Societe Generale has strong structuring capabilities and provide innovative ideas and solutions tailored to insurance companies,” says a product manager at a life insurance company in Tokyo. “They have a wide spectrum of solutions available in both derivatives and reinsurance formats, and are always able to provide a solution when a problem arises.”

Like a fixed annuity, a fixed-index annuity (FIA) provides policyholders with a guaranteed minimum coupon, but offers the opportunity to benefit from the potential upside of markets through a multi-asset exposure delivered through a custom index designed by Societe Generale Corporate & Investment Banking (SG CIB). The product is a mainstay of the US insurance market. SG CIB spotted an opportunity for the product in Japan where record low interest rates have been reducing insurance companies’ appetite to launch variable annuity products over recent years.  

“We wanted to make a better fixed-coupon product and so we introduced the first fixed-coupon index annuity in Japan,” Davoust says. “The idea was inspired by the US market where FIAs are very popular and successful and hence we brought it to the Japanese market.”

The FIA that Societe Generale closed with its insurance client is a 10-year single premium product denominated in either Australian or US dollar, where the policyholder can choose between receiving a guaranteed yield and purchasing a customised call spread on an index comprising equities, bonds, commodities and real-estate. If the index is performing policyholders can therefore receive a yield of up to 10% through the multi-asset exposure.

SG CIB’s insurance client was particularly impressed with the bank’s idea of including a volatility control mechanism that allowed pricing to be committed based on a pre-agreed model to the insurance company. The volatility controlled excess return index made it possible to fix the premium of the one-year index call spreads purchased over the life of the product, thereby eliminating the need to reprice or restructure the options payoff every year.

We wanted to make a better fixed-coupon product and so we introduced the first fixed-coupon index annuity in Japan
Arnaud Davoust, Societe Generale

Another alternative to traditional variable annuities SG CIB brought to Japan is the first foreign currency variable annuity with daily ratchet, launched in November 2017. The daily ratcheting feature, similar to the FIA, gives investors the best of both worlds: at maturity the investor receives the maximum value reached by the underlying strategy during the daily observations, while securing protection against potential future drawdowns.

The product also includes a knock-out mechanism in Japanese yen, set in a range of 105% and 200% of the initial investment, by the policyholder. That allows policyholders to lock in investment return in JPY once the investment reaches the investor’s target amount, attracting investors that have redemption money in JPY and are looking for re-investment.

“A capital-guarantee product when the risk-free rate is as low as it is in Japan is impossible to structure,” says Davoust. “But in US dollars rates are higher, allowing us to structure such products and that led us to launch the first foreign currency variable annuity with a daily ratchet in Japan with a major lifer.”

Societe Generale also offers hedging solutions for the lifer using a subsidiary that specialises in reinsurance, in order to hedge the client’s risk – mortality and lapse – as well as manage the accounting impact coming from the new product. Together the two new annuity products allow insurance companies to diversify their policy offerings and, importantly, reduce mismatches between assets and liabilities in a negative rate environment that offers few opportunities for yield enhancement, asset duration and portfolio diversification.

A structured products powerhouse

Societe Generale has also seen robust growth in its structured products business in Japan over the past 12 months, with products linked to US and Japanese equity proving especially popular. Overall, the volume of autocall and bonus structures handled by the bank’s distribution business increased by 35% in 2017–18 compared with the same period the year before.

Much of that autocall flow comprised knock-in, knock-out (Kiko) products – where investors get the principal back plus a coupon if the underlying equity index increases by 5% or 10%, but stand to lose their principal if the index declines below a certain threshold.

This year, several variations to the traditional Kiko product were introduced to reflect changing market conditions and demand from investors. One such variation is the daily Kiko. Unlike most Kiko products, underlyings are observed on the daily basis for the knock-out event occurrence, which enhances the probability of early redemption. It is an attractive feature of Japanese or US equity-linked products, given where the Nikkei 225 and S&P 500 have traded this year.

“We monitor the knock-in event daily, which allows the investor to have more chances to have a knock-out, but the coupon is slightly less than that of a normal Kiko,” says Davoust. “With Nikkei 225 and S&P 500 reaching their respective peaks, we brought in defensive Kiko schemes that increase the recall probability.”

Several other autocall payoffs with new features adapted to the market have been similarly pioneered by SG CIB in the past year. One example is the Consecutive Timer knock-in, where KI only occurs if underlying equal to or below the KI level on a certain number of business days in a row.

Another new payoff, the Glider knock-out, is particularly useful when underlying markets are range bound. The payoff is structured so that the notes will redeem early with a bonus payment if, at the end of a certain period, the underlying has not closed below the glider autocall barrier, which could be as low as 65% of the initial index level.

We monitor the knock-in event daily, which allows the investor to have more chances to have a knock-out, but the coupon is slightly less than that of a normal Kiko
Arnaud Davoust, Societe Generale

In addition to the introduction of new innovations in structured payoffs, SG CIB’s financial engineers have also launched new underlyings for its structured investment products. The first proprietary index linked to the growth of electric vehicles is one notable example.

Societe Generale believes the coming decade will see substantial growth in the market for EVs, and decided – at the behest of a corporate client – to create an index that could help investors capture that growth while avoiding the pitfalls of trading illiquid metals or the volatility of investing in metals suppliers.

The index tracks a basket composed of nickel, copper, aluminium, zinc, palladium and platinum – the commodities determined to be most exposed to the EV revolution. For example, while EV demand currently makes up a mere 3% of nickel demand, that figure is projected to surge to a fifth in the coming years and the price of the metal will ultimately 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.

Each component in the index can be invested in via futures – technically forwards for the London Metal Exchange contracts – or excess return component indices, such as the Bloomberg Commodity Index or the S&P Goldman Sachs Commodity Index.

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.
“You can also deliver value to investors through better underlyings,” says Davoust. “We show that with this index. It’s an interesting way to invest in EV through commodities.”

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