Derivatives House and Interest Rate Derivatives House: HSBC
As more stringent capital rules cut deeper in 2014, many houses became increasingly constrained by their past excesses. For those with a stronger capital position, there were many opportunities. For honing its focus as others questioned their future, and taking market share on the back of a client-centric approach, HSBC is IFR’s Derivatives House and Interest Rate Derivatives House of the Year.
The HSBC mantra of “real business for real clients” was never more apt than in 2014, as the regulatory overhaul stepped up a gear. Mandatory clearing was already up and running in the US, and the first wave of swaps products made the shift onto exchange-like platforms. For European banks it was a particularly turbulent awakening as CRD IV took effect, leaving many derivatives operations untenable.
To meet rising leverage ratio requirements, houses with a strong derivatives history accelerated the speed with which they cut positions. But with its improved capital position and a 4.6% leverage ratio that exceeded PRA requirements, HSBC reaped the rewards of a conservative risk management approach, gaining market share on the back of a client-centric business model that is closer in line with the direction of regulatory travel.
“Directionally, the way the market will be is very much where we are. The new derivatives market is coming to us,” said Niall Cameron, head of markets, Europe at HSBC. “If you look at our clients, very few of them have disappeared through the crisis. We haven’t needed to change clients and we haven’t needed to change product type, as we didn’t go into the ultra-complex stuff.”
Solutions were always at the core of HSBC’s derivatives ambitions, and with a well-balanced client mix consisting of 50% corporate and 50% financial institutions and governments, the bank was well placed to recycle risk.
“We’ve got a relatively clear view of what derivatives mean for our clients. If you have a good understanding of the client model, you are able to see the dynamics between the client and your own book position,” said Cameron.
The bank’s unique proposition to clients was its global reach. Through 55 dealing rooms around the world and a network covering more than 90% of international trade and capital flows, HSBC was well placed to provide unique insight into evolving market themes.
“Our range of products is very broad. As well as increasing access to hedging solutions, we use derivatives to open local markets when it isn’t economically viable to use cash products to access currency, rate or equity risk,” said Cameron.
At the heart of HSBC’s derivatives offering lies its rates business, which it steadily built into a global powerhouse over the previous five years. In an era of fixed income retrenchment across the industry, HSBC was one of few houses with the financial wherewithal to expand in a business that gets clobbered by capital and leverage requirements under Basel III.
And, as with its wider investment bank, the needs of its clients in the real economy were put front and centre when designing hedging and financing solutions.
“The cost of trading derivatives went up significantly for corporates and institutional investors, but it isn’t healthy for those companies not to hedge their risks,” said Elie El Hayek, global head of rates and credit. “All we do at HSBC is focus on reducing these costs, and that is why we are plugged into every industry standardisation initiative.”
A headline example was pioneering new structures for cross-currency basis swaps, which are particularly punitive in the new regulatory framework.
This came about when HSBC acted as sole hedge counterparty to a major oil company on a long-dated €2bn transaction swapped into floating-rate US dollars.
The deal was structured in a leverage ratio-friendly way involving a series of clearable interest rate swaps and FX re-settable cross-currency swaps, with the credit risk then syndicated to the wider banking group.
“At first, other banks thought we were crazy, which shows how advanced we were. But they gradually came around to it and this now forms a part of the dialogue in every transaction,” said Shahrear Haque, head of the risk solutions group.
HSBC further bolstered its expertise with corporates in the inflation space, including the restructuring of a long-dated portfolio for a UK electricity company to reduce credit exposure to its banking group and improve costs.
Meanwhile, the bank is now reaping the rewards of a concerted build-out effort on its institutional client platform, which started in 2009.
“Solvency II is a real issue for clients once more after falling off the agenda for a couple of years,” said Simon Hotchin, head of EMEA strategic solutions. “Client problems are as complex as they have ever been due to regulatory change and uncertainty.”
There is still demand for yield enhancement strategies with rates at record lows. As a result, forward-bond selling programmes, which HSBC spearheaded, spread to Asia and the US. The trend developed further in Europe with the introduction of reverse forward bonds, as clients were keen to lock-in unrealised forward gains following yield curves flattening.
The bank’s dominance in emerging markets continued to pay dividends in winning large mandates, particularly in Asia. As well as remaining at the forefront of the renminbi derivatives market, HSBC also demonstrated its prowess in providing financing solutions in the region.
One landmark transaction involved providing Hong Kong dollar funding for a Japanese bank looking to expand its operations in the region via a cross-currency structured repo.
“We are one of the few banks in the Hong Kong market that has long-term assets. We understood the regulatory needs and the client’s infrastructure, enabling us to cheapen the capital cost and make the economics look much better for us and the client,” said Guido Hebert, global head of rates structuring.
HSBC also invested heavily in technology and infrastructure as a greater portion of the fixed income product universe migrated to electronic execution. This included greater use of algorithmic execution, an area where the bank historically lagged.
“We need to move into a world where the client is doing a lot more in terms of self-pricing. It’s a different type of technology – it’s about helping clients, not about creating a black box,” said Cameron.
Significant strides were made in the equity derivatives business in 2014, in large part due to the success of the Asian operations. Of 80 traders and 20 structurers worldwide, a third are located in Asia, and a connected platform allows clients to access products around the clock in any location.
“What is different is the global nature of our platform, and we can deliver that global platform to every location,” said Marc Lemmel, global head of structuring.
With an estimated 20% market share for equity structured products for retail and private bank markets in Asia, HSBC increased its focus on algos and proprietary indices, as well as flow derivatives and equity-based financing.
One of the bank’s best-selling products was a delta one tracker on its internal “Super 10” research pieces on European and emerging markets. The GEMs Super 15 Equity Index Series offered more granularity to EM investing than traditional BRIC exposure, using rules-based indices that screen stocks for liquidity, market cap and foreign ownership constraints.
The bank also packaged short-term notes replicating the payoff of volatility and variance swaps in an EMTN wrapper, offering pure volatility exposure to investors without access to the OTC market.
“We’re not in an innovative period in terms of payoffs, but we’re seeing a lot more innovation in underlyings,” said Alain Alev, head of equity derivatives sales. “Clients are getting used to systematic strategies to enable them to play correlation, dispersion and volatility spikes, but we look for a bit of innovation on the underlying side.”
HSBC also structured a US$35m transaction for a discretionary manager linked to the newly-created JPX Nikkei 400, with additional plans for a currency hedged version.
“We’re a solid name and a solid credit, and we’re seeing flight to quality onto our platforms,” said Lemmel. “We’ve not diverged from our original strategy. We provide a consistent service through the life-cycle of our product, and that’s key to stabilisation and growth.”