Structured Products Americas Awards 2016
Risk management is by nature a communal activity. Burden-sharing and relationship-building, both within and outside a firm, are essential to long-term success.
Barclays made a number of strategic decisions over the past 12 months designed to slim its risk profile and get ahead of supervisory changes, including partnering with outside firms to share the load of regulatory compliance.
The bank also ramped up product-suitability procedures to ensure its structured products didn't fall into the hands of those unable to understand them - not by crimping customer choice, but by adopting a hands-on approach to client care.
Incoming European Union regulation on the administration, governance and use of proprietary indexes triggered a bout of soul-searching within Barclays on what to do with its lucrative risk analytics and index solution (Brais) business unit, which constructs and administers dozens of custom underlyings for a host of structured products.
The regulation aims to stamp out conflicts of interest in businesses that design, hedge, and distribute index products under one roof. A highly publicised scandal involving a UBS-issued structured note linked to a custom foreign exchange index, which was found to have been manipulated by the bank's own forex traders, thrust these conflicts into the spotlight last year and led to a scramble among banks eager to avoid the fines and reputational damaged incurred by the Swiss issuer.
Every index we design has to go through a retail distribution committee, and we have stopped certain indexes going to certain client segments if we think there is a suitability issue,
Laurence Black, Barclays
Barclays showed it was ahead of the curve by announcing the sale of the Brais unit to Bloomberg in December, a deal which is expected to be finalised in the first half of this year. The sold unit will serve as calculation agent for the systematic strategy indexes the bank will continue to generate in-house.
"One of our motivations was to increase further the distance between structuring and trading on the one hand, and the calculation and governance of our indexes on the other. Day-to-day maintenance will be carried out by Brais as owned by Bloomberg," says Michael Hosana, managing director in the equity and fund structured markets (EFS) team at Barclays in New York.
"We think this is in the best interests of our clients. We welcome the heightened scrutiny around indexes and we think we've hit on the best arrangement for managing this. We retain the responsibilities of being an index administrator, but outsourcing the actual index calculation to an outside entity provides our clients with further assurance around conflicts of interest," he adds.
Another regulatory threat looming is the US Federal Reserve's proposed rule on total loss-absorbing capital (TLAC), implementing guidelines drawn up by the Financial Stability Board last November. The proposed rules eliminate all but the most lightly structured debt instruments from qualifying as eligible TLAC, forcing dealers to alter their funding structures accordingly.
Barclays has bitten the bullet and has wound down the percentage of its funding attributable to structured notes from 30% in 2013 to around 20% at the end of last year, the bank confirms. Structured notes notional outstanding stood at £28.3 billion ($40.7 billion) at the end of 2015.
The bank has also taken a thoughtful approach to product suitability. The wilder frontiers of the structured products market are not suitable for every investor, and Barclays has evolved its client service to nudge prospective partners towards investments they can truly understand and away from structures beyond their capacity. This has helped strengthen client relations while minimising Barclays' exposure to potential mis-selling claims and the associated reputational fallout.
A hands-on approach is especially warranted when it comes to the design and sale of proprietary indexes: a business line in which Barclays has excelled, but that has recently come under the intense spotlight of regulatory scrutiny.
"We are not saying to a client: 'Here's an index and here's a hedge.' We are helping in the design stage, collaborating on underlyings, helping to optimise the index rebalancing to suit the client's needs – offering a full spectrum of service for our clients," says Laurence Black, managing director in EFS solutions at Barclays in New York.
Black gives the example of one client who approached the bank in 2015 applying for a custom index it wanted to install in a suite of structured products intended for retail investors. The client initially wanted to include a number of illiquid exchange-traded funds (ETFs) as index underlyings.
Instead of rubber-stamping the deal and harvesting the licence fee, Barclays advised the client on the use of alternative underlyings to these ETFs that would avoid the index calculation and hedging difficulties associated with illiquid constituents. The bank then optimised the index to depress the hedging costs and maximise its sensitivity to the reference underlyings.
The client was so impressed that not only did it license the index, it retained Barclays to provide the hedge, too.
"Our standards have tightened significantly in the last couple of years. Every index we design has to go through a retail distribution committee, and we have stopped certain indexes going to certain client segments if we think there is a suitability issue, or we think they don't have the ability to explain the product to their end-clients," says Black.
Barclays also considers the long-term consequences for clients - for instance, Hosana says the bank may also turn away new money coming into certain indexes if the additional volume may impair current holders' returns.