No dealer can claim to have followed a completely unique path in any given year. At Societe Generale, the bank’s structured products business was exposed to the same regulations that caught its rivals; it faced the same limits arising from the popularity of autocallable notes; and it saw the same supply dynamics in US volatility. But in each case, it went further, or faster, or found a new approach – ultimately translating into a roughly 30% year-on-year increase in volumes.
And in one important respect, it did stand alone – striking a deal to acquire Commerzbank’s retail structured products business following an auction process involving several rivals. Subject to regulatory approval, which could arrive before the end of 2018, the deal would fulfil the French bank’s long-held ambition of a leading position in Germany and catapult the dealer to the top spot for listed products in Europe.
“In structured products, the two banks have quite different models. SG covers mostly tier 1 and 2 clients in Europe, while Commerzbank has very deep penetration in tier 3. In terms of product type, 30% are very different, which helps SG become even bigger and also feeds into the strategy of becoming a top flow house,” says a person familiar with the two businesses.
Regulation gave the bank its first chance to stand out this year, as rules on trading and transparency took effect in Europe alongside new protections for investors in structured products – respectively, the second Markets in Financial Instruments Directive and the packaged retail and insurance-based investor products (Priips) regime.
The bigger the player, the bigger the challenge. Months of groundwork led by a 40-strong-core team meant SG has been able to produce more than 330,000 key investor information documents (Kids) since Priips took effect in January – 150,000 of those on day one – and also meet a Mifid II requirement for the publication of costs and charges. In SG’s case, that information had to be published for more than 20 million products.
“For the core team and the whole community who worked on regulatory preparedness, from the front office through all of the support functions, it’s a great sense of achievement, because everyone did so much work to be ready,” says Jean Francois Mastrangelo, head of pricing and solutions for Europe, the Middle East and Africa at Societe Generale.
Clients appreciated the effort. “All banks were ready for Mifid II to some extent, but SG was advanced from the start, and up-and-running for more flexible products and payoffs,” says a structured products originator at a European wealth manager.
A private banking client agrees. “[SG’s] capabilities and flexibility to provide Kids for all types of payoffs was, and is, outstanding.”
It was also well-timed. Rather than halving production as the bank’s assembly line ground to a halt – SG’s fear – the bank’s automation efforts enabled it to capitalise on increased demand for retail products. Issuance volumes jumped 20% in Europe and 30% globally during the first nine months of 2018.
We massively increased our alternative risk transfer set-up to immunise the exotics books during the second quarter and the summerAlexandre Fleury, SG
Shaky compliance wasn’t the only factor that could have cut down this business – risk management was another. Because autocallable notes dominate the retail structured products market, all issuers end up with essentially the same set of correlation and convexity exposures, which can result in hedging losses when underlying markets are sliding.
SG wanted to grow the business while reducing these risks. It did so by prioritising the emerging discipline of alternative risk transfer (ART) – the slicing, dicing and repackaging of structured products risk to create attractive payoffs for sophisticated investors. Year-on-year, the bank distributed 50% more risk this way.
“We massively increased our alternative risk transfer set-up to immunise the exotics books during the second quarter and the summer,” says Alexandre Fleury, head of equity derivatives at SG. “We have managed to increase the exotics business with clients on the other side, while at the same time decreasing the sensitivity to exotic parameters in the book, and are now adopting a one-in-one-out approach to risk.”
A difficult first quarter for SG’s equity trading division underscored the importance of that approach. While US flow-focused dealers capitalised on February’s volatility spike to deliver bumper trading revenues, the French bank’s numbers flat-lined. In part, that could be traced back to the long-dated volatility positions arising from the structured products business – the wrong part of the curve to be long when short-dated vol jumps in response to a crash.
At the heart of SG’s risk-reduction plan was a democratisation of popular ART exposures. Dispersion – a bet that single-stock volatilities will outstrip index volatility over the long term – was packaged into index format and offered in securitised formats that are easier for pension funds to buy. For more sophisticated clients, the bank sought to increase the appeal of some strategies by removing inefficiencies – for example, the risk that bankruptcies could erode the performance of geometric dispersion trades. So-called ‘ART squared’ deals saw exposures combined – sometimes across asset classes – to create improved risk/reward profiles for well-versed ART clients.
“As well as offering more innovative and cross-asset products to sophisticated clients, we’re also finding more clients for the historical blockbusters. We’re offering the bread and butter of risk transfer, such as dispersion, in a friendly format that real-money clients can invest in,” says Mastrangelo. “That’s really the two axes where you develop ART: new products and new clients.”
SG was not alone in packaging dispersion and other light exotic payoffs into indexes, against which swaps or securities could be sold to investors of all stripes. Here, investors say the French dealer’s edge was its ability to trade in size.
“Most banks are showing off their dispersion indexes, what kinds of baskets they’re axed on, what size and pricing they can do and what their trading costs are. SG was just more competitive,” says a London-based institutional investor. “With some banks, the second you get into proper sizing, pricing deteriorates. SG was better with that.”
One trophy trade saw a large real-money client trade €5 million vega of total return swaps linked to a custom dispersion index, enabling the firm to access an exposure it was unable to book in traditional variance swap format.
Other ART deals were smaller, but helped expand the bank’s institutional business, says Mike Bayley, SG’s UK institutional sales head: “Opening up risk transfer to a wider audience – including complex strategies that were previously only available to sophisticated investors – has led to us being able to deliver solutions to more institutions.”
Another chance for SG to differentiate itself came in the US dollar rates market, where longer-dated volatility has in recent years been cheap relative to short-dated vol. That reflects a steady supply of US rates volatility resulting from the issuance of callable, dollar-denominated bonds to Taiwanese insurers, and generates a rare opportunity for investors to collect positive carry by rolling a long volatility position – akin to being paid to hold insurance.
The bank traded more than €3 billion notional linked to forward rates volatility strategies – joining other dealers in the trade. But it also took it a step further, by packaging the strategy in an index that reflects one-year forward volatility entered through a combination of long and short swaptions trades. It is thought to be the only one in the market, enabling investors to gain exposure to the trade via swaps or certificates. The SGI VRR US launched in April and was described by one UK-based private wealth manager as “an idea I really like for a multi-asset portfolio such as ours”.
A UK-based asset manager, one of more than five institutions that traded VRR in the first six months, added the index to a portfolio of tail hedges to mitigate the cost of carry associated with long equity volatility exposures.
“We believe VRR adds significant value to our process. It’s difficult to know whether rising volatility is a short-term stress or something that will stick around for longer. Being long volatility through VRR means we can wait one or two more days to see,” says the asset manager.
In August, regulators in Taiwan classified the bonds as overseas investments, curbing the amount domestic insurers are allowed to hold, and instantly hitting issuance volumes. The changing dynamic raises questions about the future performance of a largely flow-driven dislocation, but the asset manager is not concerned.
“If the flow was to disappear, the long end of the term structure would rise and you would make a lot of money. You’re not really exposed to the trade disappearing, but if it does disappear it’s a relatively good outcome. You have basically an insurance on your insurance,” he says.
On the downside, the strategy is short volatility at a specific tenor, which could deliver losses in some scenarios: “We have mitigated that with some other positions and believe it’s manageable, so it’s something we’re comfortable with,” the asset manager says.
SG believes VRR will continue to gain traction. “Whenever you design a strategy like that, you need to be comfortable there’s an ongoing opportunity. We strongly believe it’s an opportunity that should persist,” says Bayley.
There were a number of notable deals in the distribution business as well, where the bank received seven million quote requests – and printed 29,000 tickets – during the first eight months of 2018, a three-fold increase in as many years. Among those, SG offered leveraged exposure to a diversified real estate fund, and generated €1 billion of investment in carbon arbitrage notes from Asia, Europe and the US.
In Europe, the bank recognised demand for philanthropic investment with what it claims is the first charity-linked autocallable note. Cristal Solidarité, a 10-year note whose performance is linked to the 80 largest French companies, includes a double donation mechanism that sees SG paying an amount equal to 0.1% of the initial investment to four associated charities, plus a subsequent donation linked to performance.
Launched and structured in conjunction with SG Private Banking, more than €300 million was raised from over 3,000 investors in the first six months, triggering the issue of two further charity notes. The first donations of €300,000 were awarded across four charities in October.
And in the US, SG made its first foray into the $50 billion-plus fixed index annuity market. In partnership with asset manager Janus Henderson, SG delivered the first equity-only long-term savings structure for Athene Life insurance, raising more than $850 million, according to regulatory filings, as of June 30, 2018.
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