Warrants proving a big opportunity for Asia private banks

With US rates plumbing new depths this year, demand for the once-ubiquitous capital-protected structured product has dried up almost completely among private bank clients in Asia. For some distributors, this presents an opportunity to sell different products, such as over-the-counter warrants.

Others say it’s too difficult a sell for clients who are used to the principal-protected products, but they’re missing out on what has turned out to be a booming market.

With US dollar interest rates close to zero across all the typical tenors, the zero-coupon bond component of the products used to provide that protection simply does not yield enough to allow the product to provide an attractive return. Simply put, the higher the coupon of the bond, the more there is to invest in the options that fund the payoff.

Some manufacturers and distributors have responded by pitching what are effectively the same structures to clients, but with lower protection, which frees up a bit more funding to buy options. 

Others looked to try something new entirely. They reasoned that, if there is minimal value in buying the zero-coupon bond part, why not ignore it and essentially buy the option part on its own?

The same low interest rates problem. The same customer base. But very different solutions. 

It is now crystal clear that securitised options – or warrants – have been the more successful of these two structuring tweaks with private bank clients in the Asia region. Those private bank distributors that are yet to adopt and propose warrants to clients, ought to be taking notice.

These warrants come with various underlyings. They could mirror the listed warrants traded on exchanges, and offer a bull or bear position on an equity index or stock. The biggest demand has been for the relatively new dispersion and outperformance warrants though, which are based on market-neutral strategies designed to perform whatever the direction of the equity markets.

On these structures the underlying is the dispersion of a basket of selected stocks, or the outperformance of one basket of stocks against another basket. Over the past year, these products have gained a large market share as appetite for capital protection waned.

Yet beyond the industry’s larger players, there remains a not-insignificant number of private banks that continue to eschew warrants. Manufacturers have tried to convince reluctant distributors of the value of products, such as dispersion warrants for clients, but so far to no avail. 

In explaining their reticence to embrace warrants, they argue that the products are tricky to sell. Their wealth clients, they reason, usually prefer to receive rather than pay a premium.

They also argue that concepts such as dispersion are difficult to explain to clients; that doing so requires a considerable investment in client education that ultimately might not bear fruit.

The billions of dollars of sales on dispersion warrants made already by the likes of UBS, DBS and Credit Suisse would suggest that such arguments hold little weight, however.

The growing market share of warrants proves that Asia’s private wealth investors are becoming more willing – when appropriate – to fork out some premium to get some upside. And those that have done, benefited handsomely this year, tripling or even quadrupling their investment on the option premium, according to one wealth management sales executive.

It is a trend that presents an opportunity for any private bank willing to make the case to clients.