At first glance, the shake-up in this year’s Risk España rankings belies the steady progress of the Spanish economy over the past 12 months. Look closer though, and it becomes clear that the dealers themselves are behind the upheaval.
While BBVA retained the top spot overall, poaching the equity derivatives crown from Santander in the process, it is lower down the order that the real story lies. Two non-Spanish banks in particular catch the eye: JP Morgan, which vaulted up to second position in the overall rankings and advanced six places on 2015 to grab the number one spot in rates; and Barclays, which nabbed third place overall following a seventh-place finish in 2014.
The progress of these two has come at the expense of Santander, which tumbled to tenth overall, and Societe Generale, which dropped from third to sixth in the rankings. Local lenders Banco Sabadell and La Caixa took fourth and fifth places, respectively.
This shift occurred against a backdrop of relative stability in the Spanish market. Gross domestic product grew 3.1% in 2015, up from 1.4% in 2014, and the International Monetary Fund (IMF) is predicting a healthy 2.8% expansion this year. The IMF’s fiscal monitor estimates the country’s deficit will shrink to 3.1% in 2016, down from 9.5% five years ago, suggesting that structural reforms to the labour market and public finances prescribed by the government in the wake of the crisis continue to have a positive effect on the national balance sheet. The IMF remarked that the ongoing fiscal rebalancing is taking place on a foundation of “strong economic growth” and is being helped along by the low interest rate environment, which is lowering the cost of the country’s debt servicing.
However, this same rate environment is putting the squeeze on Spain’s financial institutions. “These days, banking activity dynamics are affected by the low interest rate environment, essentially making our lives harder. It’s not affecting capital markets activity or the way we price things as much as on the lending and mortgage activity side,” says Carlos Ciervide, head of markets, Iberia, at Santander in Madrid.
Net interest income fell at the bank’s Spanish unit by 5% in 2015, with interest rates and “strong competition in loans” cited as the chief culprits. BBVA, meanwhile, swallowed a €154 million loss on its real estate activities in 2015.
Regulation is also putting the dampeners on the sector’s ambitions. Dealers are anxiously awaiting details from the Basel Committee on Banking Supervision (BCBS) on an interest rate risk charge, with the smart money betting on the introduction of a souped-up Pillar 2 approach, which would put national regulators in the driving seat when it comes to assigning required capital levels.
The BCBS’ overhaul of market risk regulation, through the appropriately named Fundamental review of the trading book (FRTB), is also giving dealers the jitters. One dealer says the pain will be felt greatest by local broker-dealers and pure-play investment banks, which are still wrestling with how they model risk weighted assets and the balance-sheet constraints imposed by the leverage ratio. Then there’s the swarm of changes upsetting the non-cleared derivatives market, the cumulative impact of which scythed notionals by 30% last year worldwide.
Dealers able to transform these challenges into opportunities, however, have enjoyed a gold rush. Barclays is one such firm.
As part of the British bank’s restructuring in the wake of the financial crisis, it sold off its Spanish retail and small and medium-sized entities businesses to Caixabank in 2014, freeing it up to focus its efforts on a smaller cadre of jumbo clients. Its area of expertise now is providing tailored, event-driven solutions to these big hitters.
Javier Quiros, head of financial institutions structuring for Iberia at Barclays in London, says: “Regulation is substantially affecting the uncollateralised business. This has led us overall, as an industry, to increase the associated hedging costs and has reduced the appetite from institutions generally to accommodate long-term hedging strategies. We have been focused on efficient use of capital for the last two years, and what helps us is dealing with a more centralised set of clients. This allows us to increase service to our largest clients because we are recycling capacity from some other places.”
He adds that the bid among financial institutions has been for foreign exchange hedges and structured trades to reduce regulatory capital consumption. The rates desk has also done brisk business as local lenders have turned to derivatives to protect their net interest income margins.
Corporate prices converge
Corporates have also fuelled demand for rates protection. An increasing number of clients are approaching the dealer for pay-fixed forward-starting swaps with four- or five-year knock-ins, which they can use to hedge the issuance rate of future bond issues. As European interest rates have scant room to move lower, it makes sense for firms to hedge against a rise in the medium term.
Corporates have also turned to dealers to hedge their exposure to emerging markets – especially those with operations in Latin America. Economic upheaval across the continent played havoc with local currencies, spurring corporates to strike forex hedges to stabilise their earnings.
Interdealer competition for corporate accounts has ramped up in recent years, as banks have become savvier at pricing non-cleared derivatives to account for valuation adjustments (XVA), collateralisation and regulation.
“In the corporate space a couple of years ago, there was a very diverse range of pricing outcomes,” says Juan Flames, head of risk solutions, Europe, Middle East and Africa (Emea), at Barclays in Madrid. “I would say there has been more of a convergence among financial players to incorporate the changes in regulation when it comes to pricing, both from a credit risk perspective as well as from a cost of balance-sheet perspective,” he adds.
Clients are getting smarter too. Today’s corporates seek a closer alignment of purchased derivatives with International Financial Reporting Standards hedge accounting rules and are more sensitive to pricing variations stemming from dealers’ estimates of counterparty valuation adjustment (CVA).
Banks are having to raise their game. BBVA says that demand has spiked for CVA optimisation trades, and BNP Paribas notes growing momentum for trade collateralisation.
Dealers are also looking to outfox each other on the valuation adjustments front. ‘XVA optimisation’ is this year’s buzz-phrase of choice.
The head of fixed income for Iberia at an international bank says: “We are in a competitive environment. We know from talking to corporate clients at what price they executed and we can determine from that data who is charging XVA and who isn’t. There are discrepancies and not all platforms are the same. If you have a big, big platform, and you have a lot of dedicated resources to the derivatives business, you can’t stand by and lose business. At some point you have to find a way to compete or subsidise certain business lines with other products to make sure you capture client flows. We can’t afford to be idle – we have to find a way to get into the game.”
Quiros at Barclays believes international dealers hold an edge over domestic lenders in this arena. Less sophisticated firms take a more granular, trade-by-trade approach to managing their XVAs, whereas the global heavyweights have adopted centralised counterparty risk trading functions, enabling them to net exposures across different regions and businesses, he says.
Hunger for yields
Corporate accounts are one engine of growth. The Spanish insurance sector is another. A number of banks featured in the rankings said insurers formed the cornerstone of their business in 2015, including top-placed BBVA.
“Insurance companies are looking for yield – as you can imagine, given the low level of interest rates and more strict regulation on solvency capital. How do you do that? In the structured products part of the business we have been providing ad hoc ideas, maximising returns from a solvency capital point of view. Hedging derivatives and solvency capital-optimising deals have also been on the spot,” says Juan Garat, head of global markets sales and structuring at BBVA in Madrid.
The thirst for yield is no small matter for Spanish life carriers. Average guarantees on legacy business stand at 6%. With the Spanish 10-year yield at 1.47%, these firms face severe reinvestment risks.
BBVA’s Garat oversees a team dedicated to institutional and retail structured products in Spain comprising sales people, structurers, researchers and traders. All work together in a configuration that has served BBVA well for years.
A subset of this team is earmarked to service insurance companies. BBVA claims it is the first Spanish bank to establish a bespoke coverage channel for this industry – and, though its competitors jumped on the bandwagon, it maintains an unrivalled presence in the sector, having an ongoing business with 90% of life and general insurers in the region.
Insurers have warmed to structured credit products in particular, says Garat – including credit-linked notes (CLNs). The most popular flavour across the industry are CLNs that reference government bonds, where the swap counterparty exchanges the associated fixed coupon for an alternative cashflow. Insurers like this structure because of the underlying sovereign risk, which attracts a 0% capital charge under Solvency II.
“Spanish and Italian government bonds are popular underlyings. Insurers are not going to buy Bunds in this environment, but they do want sovereign risk because of the good capital treatment they receive,” says Garat.
On the retail side, appetite is concentrated among products referencing Spanish blue-chip stocks and indexes. However, political uncertainty arising out of the country’s inconclusive elections in December – and the subsequent failure of the various parties to form a government – saw a stampede into principal-protected structured funds, according to Luis Muñoz, head of distribution for Iberia at Societe Generale in Madrid. The French dealer scored sixth place in the structured products and exchange-traded funds category.
Muñoz adds that retail clients are also seeking to extend the maturity of their portfolios in order to take advantage of the associated illiquidity premium – a rational response in a period where European interest rates do not look like advancing any time soon.
Stormy times on the horizon
BBVA’s structured-products team has witnessed the same trend, but say the story is different in the wealth management arena.
Jesús Floristán, director of equities Europe in global structured solutions at BBVA in Madrid says: “Through the asset manager and insurance channels we have seen longer maturities popular for funds and unit-linked distribution products – this is explained by low interest rates but also by narrower credit spreads. [However,] on the private bank side we have seen the contrary – shorter maturities between 18 months and two years, which can be explained by the fact these clients are less risk-averse and are willing to put more capital at risk – which allows the maturity of the product to be shorter. In 2015 the bank racked up an 80% increase in sales volumes for its equity-linked structured notes.
Troubles abound for the Spanish economy going into the second half of the year. Fresh elections in June may bring about a new government that could kick the previous administration’s reform programme to the kerb. Elsewhere, the UK’s referendum on its continued membership of the European Union carries the potential to knock financial markets off course.
For dealers, though, this is business as usual. BBVA’s Garat says: “The environment in Spain has been complicated over the past 12 months, so we are getting used to it. We hope uncertainty will end in June, but this is nothing new – unfortunately.”
HOW THE POLL WAS CONDUCTED
Votes were received from dealers, brokers, corporates and asset managers in Spain. Participants were asked to vote for their top three derivatives dealers in order of preference in products they had traded over the course of the past year. The survey covered 18 derivatives categories, divided into interest rates, currency, equity, structured products and risk advisory. The votes were weighted, with three points assigned for first place, two points for second and one for third. Only categories with a sufficient number of votes have been included in the final results. The survey includes a series of overall product leaderboards, calculated by aggregating the total number of weighted votes across individual categories.
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