Emmanuel Ramambason & Cedric Podevin

Clients in Asia are often more adventurous than in Europe and the US when it comes to structured credit. Two derivatives specialists from BNP Paribas in Asia discuss some of the innovative structures now on offer in the region

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Q: It is often assumed that Asia lags behind Europe and the US in the development of new products. Is that the case in structured products? What is the state of development of credit-related structured products in Asia?

A: As far as synthetic and cash structured credit is concerned, the notion that Asia lags behind Europe and the US is not really true: we see many complex and advanced structures trading in Asia. Asian investors have come up a long way and pretty much as fast, if not faster, than European investors in the use of credit derivatives, whether as investment tools or as hedging and rebalancing tools when managing their natural credit exposure.

Regulations are opening up and in most of the large Asian countries, credit-linked notes, cash collateralised debt obligations (CDOs), securitisation products and synthetic CDOs are accepted. Typical structures range from the vanilla single-name note, which is like a credit-linked note, often with some embedded credit and interest rate optionality, to correlation products where the credit exposure is on a basket of single names.

As the index tranche interbank market has developed in the past two years, the modelling and pricing of CDOs has rapidly evolved and this has made possible new CDO structures such as forward start CDOs and options on CDOs. We still see some appetite for CDOs of asset-backed securities and CDOs-squared.

Most bespoke CDO structures in the region are either self-managed or managed by a third-party manager. In most cases, principal of the initial investment is at risk on different types of credit events, but we are also seeing principal-protected structures where a bank provides a formal guarantee on the principal invested while the coupons are at risk.

Over the last 18 months, credit CPPI products have established themselves as a new product class, complementary to the older types of structured credit products. The credit CPPI concept has already evolved with a variety of versions now being pitched. The first and simple ones were based on a leverage a static index-based long-only strategy. The latest and more advanced ones leverage on a mix of managed relative value strategies with a manager able to pick and choose the timing of entry and exit, and level of exposure to different types of credit strategies.

Q: Are there areas within Asia where clients and banks might have a higher appetite for risk than perhaps in Europe and the US? Where are these areas, and why might they be less risk averse than elsewhere?

A: Some of the older markets in Asia have witnessed an evolution similar to Europe with a gradual development of a retail and high-net-worth or private bank structured credit market, especially in Australia, Singapore, and Hong Kong. In these places, a mix of products is offered from low risk/return to high risk/return. In some cases, retail clients in Asia are eager to take equity risk through the use of warrants and listed options; similarly we have seen these retail clients looking for high risk and high potential return products in the structured credit area.

This is not to say that the risk awareness is not as good as it may be elsewhere. Most credit products have developed under the scrutiny of the regulators and require extensive efforts in order to explain the risks and offer transparency on structures that should be well understood by the selling networks and the end clients.

Q: Hybrids are a particularly exciting area in Asia right now. What are some of the structures BNP Paribas is working on right now? Why are they appealing to clients?

A: Asian investors have been keen on credit/interest/FX/equity hybrids for a while and the variety of structures offered is such that we shall only list a few:

- credit contingent currency swaps;

- credit-linked notes with exotic interest rate-linked coupons;

- convertible bonds, whether classic or with exotic features;

- CDOs with exotic interest rate notes as collateral.

The appeal is also different depending on the client constraints and the type of payoff. Generally one is looking to leverage a credit view to offer a return that is enhanced from a classic interest rate/FX/equity structure.

Here are a few country-specific examples:

An unusual and unique product was recently offered in Taiwan where through the structuring of a hybrid cash-synthetic-exotic interest rate structure, we have enabled clients to restructure a large existing onshore Taiwan dollar exotic bond portfolio that had underperformed in recent interest rate moves. The new structure is a collateralised bond obligation (CBO) sold to Taiwanese investors. The underlying CBO risks include a mix of structured Taiwan dollar bonds, a US dollar corporate CDO and some contingent cross-currency swaps.

In Japan, we have seen appetite from clients on Japanese yen quantoed (that is, deliverable in another currency) bespoke CDO structures based on global portfolios where the contingent coupons are linked to yen constant maturity swap spreads. The particular yen interest rate curve level and shape added to the need to diversify exposure from a largely domestic credit portfolio.

In the Philippines, a variety of structures have been shown in US dollars, for example callable interest rate range accrual structures with a principal at risk on the Philippine sovereign credit; and callable leverage notes with exposure to the Philippine sovereign credit. In this case, onshore clients are keen to leverage their bullish view on their own sovereign risk to extract a yield pick-up from a typical pure interest rate exotic structured note.

Lastly we should mention the development of equity/credit hybrids through the various products based on equity default swaps, whether single names or more often in the form of baskets. Asian investors, Japanese in particular, have started to look at rated and unrated CEDO (collateralised equity-trigger debt obligation) structures. In CEDOs, the default of a given name is triggered not just by one of the typical credit events but also by the drop of the stock price below a preset trigger level (typically 60% to 70% lower than the initial levels). Some long/short versions have started to appear that are also of interest.

Q: What sort of clients are buying the various credit structures available in Asia?

A: Institutional investors and hedge funds constitute the largest part of our client base but corporates are increasingly turning to credit derivatives for both liability hedging and investment. Retail investors are also becoming more active.

Q: Is there anything you think the US or Europe could learn from the structured products market in Asia? Can you describe some of the structures or techniques that are being used in Asia that are not available in the US or Europe?

A: Aside from the use of structured credit products as investment products or as liability hedging tools which also apply to Europe and the US, Asia has developed particular products in response to specific regulatory climates which are not relevant elsewhere, so it's difficult to see parallels. A context such as Taiwan for example is unique and the solution we adopted there is unlikely to be copied in Europe. Still the technology developed will be used again whether on other Asian markets or in Europe as we see a growing mix of cash, synthetic, interest rate and FX exotics which are needed to engineer bespoke client solutions.

Some of the innovations we have seen in the Philippines, Taiwan or Japan have gradually become mainstream and are now also traded in Europe. A good example is constant maturity credit default swaps. We saw CMCDS-linked structured notes developing rapidly in Asia in 2005 and they have now become popular in Europe. Asian clients seem to have an appetite for innovation which in some ways is more adventurous than in Europe.

Emmanuel Ramambason is head of credit trading and derivatives for Asia in Tokyo and Cedric Podevin is in the credit derivatives structuring team for Asia ex-Japan in Hong Kong

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