The Asian structured products market offer a timely example of Warren Buffet’s observation: “It’s only when the tide goes out that you learn who’s been swimming naked.”
The past year has seen Asian exotics desks lose several hundred million dollars, as equity-linked product portfolios blew up in the fourth quarter and dealers struggled to cope with market swings. Amid all this, Societe Generale has managed to not just hold its own but also come up with ideas that helped customers switch products in line with the market tide and create solutions that reduced risk.
The bank’s foreign exchange hedged indexes for equity-linked products, geometric dispersion notes, quantitative index solutions for China structured products and a restructured rates offering are some of the standout innovations that have benefitted clients and were quickly aped by competitors. These solutions are a testament to the bank’s product innovation capabilities and enhanced risk recycling that are complemented by strict product governance, increased digital trading, automation and expansion into markets such as Malaysia and Thailand.
The French bank, which is well known for its structured equity investment solutions, has built a cross-asset focus and expanded its offering to cover rates, credit and foreign exchange over the past two years. These products have contributed to an 11% increase in the value of traded notionals in the last 12 months.
“Today, we offer a very diverse offering to our clientele,” says Thomas Decouvelaere, head of structuring for Asia-Pacific at Societe Generale. “We have pioneered successful products across not just equities but fixed income too. We now show our clients 10 structures every day versus one or two a few years ago.”
All this has been made possible by building an onshore sales presence in markets from Australia to Malaysia, customising solutions for local markets and automation. The number of automated quotes climbed 48% last year and the number of automated trades rose 53%. The bank handled 35,000 requests for quotation on average every day last year, up from 20,000 the previous year.
Automated trades made up almost a third of the bank’s structured product volumes for the private banking business in Hong Kong and Singapore last year and is expected to increase to half with the next two years, says Decouvelaere.
A key to its success in Asia has been Societe Generale’s ability to constantly offer small tweaks to structures and payoffs, regularly come up with pioneering solutions.
Monitoring product lifecycle
The advisory setup of the bank allows it to monitor the product or solution from inception to maturity and adjust in line with changing market conditions.
For example back in 2016–17, the large insurers and pension fund clients were investing in long-term range accrual products, with 15-year tenors. These products offered investors a way to gain from the steepening US dollar rate curve.
Last year, those clients began to be concerned by the flattening of the rate curve and asked Societe Generale to come up with cross-asset solutions to mitigate the risk that could negatively impact the range accrual coupons.
The bank immediately responded by proposing to lengthen the product maturity by one or two years giving room to add additional bespoke exposures such as credit risk. While these would reduce the maximum possible coupons level, Societe Generale could propose safer range accrual barriers, even negative barriers.
“Our solution came to the fore when the curve actually inverted later,” says Decouvelaere “We are probably the only bank capable of mixing multiple exposures with very long-term and complex structures. Our flexibility has been helped by our increased local presence in markets.”
FX hedged index
Another product that speaks for Societe Generale’s structuring capabilities is a foreign exchange hedged index that mitigates the quanto risk for clients and dealers.
Societe Generale launched the index in December and offered it to wealthy investors through Hana Financial Investments, a South Korean securities house. The product has attracted about $1 billion in investment so far, the bank says.
The autocallable securities, which pay investors a competitive coupon linked to the worst-performing benchmark in the basket are denominated in won, but the options and futures that dealers use to hedge the issuance are denominated in the home currency of the index such as the US dollar for S&P 500 or Hong Kong dollars for HSCEI.
This leaves banks with forex risk to manage. Dealers that issue autocallables are short the foreign currency/won vega and gamma – the exposure to movements in volatility, and the rate of change of sensitivity to moves in the underlying, respectively – as they do not want the exchange rate to move. Dealers struggled to hedge this risk in HSCEI-linked Korean autocallables during the 2015 China Black Monday episode.
To take on this risk, dealers charge investors for smoothing currency gyrations, which is referred to as the quanto adjustment, and this is about 1% of the upfront value of a typical autocall contract. But by using forex-hedged indexes instead, dealers can offer a 0.5% to 1% increase in coupon per annum, or a 20% boost in yield.
The hedged index works by investing in one of the underlying benchmarks and adds a forex forward to it, which hedges the currency risk of the benchmark versus won. The index is rehedged on a monthly basis.
The forex forward is put in place monthly and the notional on which the forex forward is based is reset at the start of each month. As a result, the index level is hedged at the start of the month, but the additional intra-month performance will not be.
This means the gains or losses on the index during the month can be affected by currency moves until the position is rehedged at the end of the period. The impact though will be minor. For example, if the index went from $100 to $105, but the forex rate fell 2%, there would only be a 10 cent loss in value.
Another index that Societe Generale introduced was a quant index-linked wealth management product in partnership with China Minsheng Bank.
The Minsheng Macro 1 index was launched by CMBC’s asset management unit in partnership with Societe Generale last December and has attracted $1 billion so far.
The multi-asset index uses a quantitative strategy to determine signals for when to trade. It is said to be one of the first so-called signal indexes underpinning a non-guaranteed wealth management product in China. A decline in lending rates has led Chinese investors to explore global assets and alternative structures to enhance yield. The product has returned 16.55% since inception.
The Minsheng Macro 1 index consists of stock and bond futures in developed markets including the US, Japan, Germany and Australia, as well as commodities. Societe Generale provides hedging services on the strategy. Each month, the French bank receives the global asset allocation instructions from CMBC’s asset management unit, and then hedges the options with relevant instruments. The volatility of the index is targeted at 5%, the French bank says.
Most of the investment in the product is linked to a fixed income portfolio – typically Chinese government or supranational bonds – that would generate a fixed payout of 4% a year. CMBC will retain a 1% coupon and use the other 3% to buy a call option on the index with Societe Generale. The maximum loss in the event of a default by Societe Generale is the premium spent on the option – 3% – as there is a 1% minimum coupon.
Societe Generale focuses on volatility control to achieve stable realised volatility for the index regardless of the investment manager’s decision to allocate to equity or fixed income, or a mix of bot. It recycles the volatility exposure through its trading book and other liquid derivatives such as listed or over-the-counter options.
The bank also thought out of the box to come up with geometric dispersion strategies as part of its risk recycling efforts. Given the bulk of the business in Asia is based on the worst-performing index, the business would be exposed to covariance risk. Societe Generale typically unloads Asian risks globally but has seen pick-ups in the interests of hedge funds in such products, says Decouvelaere.
Societe Generale proposed stocks as an alternative universe for geometric dispersion. A hedge fund manager says while he was keen on the geometric dispersion idea, he was worried about the risk of bankruptcy on specific equity stock.
The French bank came up with a solution wherein it managed to cancel the bankruptcy risk in the event of default of one equity in a basket of dispersion. When a stock drops below a certain percentage of the initial price then it is removed from the dispersion basket, thus protecting the client.
Societe Generale’s solution was not “only innovative but immediately solved the problem and this made the trade very appealing”, the hedge fund says.