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Saturday, 18 November 2017

Derivatives House: Societe Generale

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Balancing act

Sweeping regulatory reforms and record-low rates sounded the death knell for many derivatives businesses. But for Societe Generale, with its rich financial engineering history, an opportunity emerged. For expanding its equity expertise across asset classes to solve complex problems that could not be addressed with a siloed approach, Societe Generale is IFR’s Derivatives House of the Year.

The global financial crisis forced banks to reassess their derivatives activities after new rules slapped hefty capital charges on many instruments and hiked the cost of holding assets on balance sheets. As an equity derivatives stalwart – and without the burden of legacy fixed income swap books – Societe Generale embarked on a strategy to become a balanced, full-service derivatives powerhouse.

In 2016 – 30-years after completing its first derivatives trade – the French dealer can lay claim to a truly cross-asset derivatives franchise, grabbing market share from European rivals and using its engineering expertise to compete with US giants.

“In an era where banks have to make positioning choices, SG has chosen to become the reference bank for derivatives,” said Franck Drouet, global head of markets. “With 30 years of derivatives expertise behind us, our platform has evolved from equity derivatives leadership, to cross-asset solutions, to a fully integrated platform today.”

A reshaping of the global markets division in 2015 introduced a multi-asset approach to client advisory services. Dubbed “One Mark”, it aimed to break down silos to foster innovation through the transfer of expertise across the bank. From a previous equity bias, trading revenues were evenly split between fixed income and equities during the first half.

“We’ve brought down the silos and the circulation of information is something we have monetised for the benefit of clients and of the bank,” said Marc El Asmar, global head of sales for the global markets division. “With key clients, we’ve become a true partner. For multi-asset desks of sizeable asset managers, when it comes to derivatives, SG is the counterparty they deal with most.”

The bank’s 2014 acquisition of Newedge was crucial in completing the derivatives set-up, providing agency and clearing capabilities to align with the direction of regulatory travel. Prime services revenues were up 9% for the first three quarters of 2016 – defying a slump across the industry.

SG made similar headway in its digital transformation, improving efficiency for the bank and its clients by bringing all pre/post-trade and execution services under the SG Markets umbrella.

The efficiency drive bore fruit as return on equity hit 11.4% for the first three quarters, up from 7.9% for full-year 2015 and 5.3% for 2014. That was achieved with a Basel III total capital ratio of 17.6%, up from 14.6% two years earlier.

Fixed focus

Fixed-income trading provided the bright spot for SG in 2016. Revenues exceeded €2bn for the first three quarters – almost 20% up on the year-earlier period. Light exotics revenues more than doubled in the first eight months, while flow added 15%.

The One Mark approach proved its worth when a year-long effort with a large asset manager culminated in one of the biggest interest rates swap trades of the year. At €10bn notional, the macro strategy highlighted the bank’s capacity to deal in size, and was executed against an illiquid backdrop over just two days.

“Rates was the biggest contributor to our outperformance,” said Pascale Moreau, global deputy head of FIC sales. “We have the same client-centric origination approach and can import expertise from our well-known equity franchise. Our DNA is based on financial engineering – we’re able to present innovative products that really appeal to clients.”

Taking expertise from equities, the bank traded rates variance swaps with equity players, enabling them to hedge Fed rate hikes with a familiar structure. For rates players, the instruments mitigated slippage risk compared with more commonly traded swaption straddles.

One asset liability management desk at a European bank was able to grab a 40bp pick-up over sovereign yields with a €1bn nominal trade that swapped inflation-linked bond proceeds into a non-inflation coupon. For a European pension fund, SG devised a swap replacement strategy that comprised a series of optimised payer swaptions for a more efficient duration hedge with manageable cost of carry.

SG’s long-standing volatility expertise proved its worth when clients faced negative deposit rates, calling into question long-held assumptions of a zero floor. According to an investment director of a multi-asset fund, widely used SABR models became irrelevant when swaptions prices fell through the floor.

“SG ran a lot of pricing on normal volatility pricing tools – it relied on a floor but was far enough below yields that you could make sense of the pricing model. We got a lot of data on vol and skew that I could rely on when we couldn’t rely on SABR models,” the client said.

In credit, the bank increased CDS flow activity, trading US$4.5bn in iTraxx Main, US$2.5bn in Crossover and almost €4bn of single names during the September roll.

The bank became a top dealer for European credit-linked notes and the leading house in the Nordics for yield enhancement through CLNs and tranches. In Asia, SG raised almost US$6bn-equivalent in the credit and financing business.

“SG has good research, consistent aggressive pricing and is very strong on more innovative payoffs such as index tranches,” said the head of investment solutions at a Nordic bank.

Over €1bn of callable bond repack structures were sold to European insurers, enabling clients to benefit from credit volatility by selling government bonds and reinvesting in a higher-coupon callable note.

Equity mainstay

SG’s success in fixed income proved timely as a structured products slump resulted in a 23% fall in equity trading revenues – albeit against a record 2015.

“Our objective has been to reduce the volatility of results,” said Richard Quesette, global head of equities and derivatives. “Our risk-transfer initiative has been crucial in enabling us to grow our activities and what’s really important is the diversification of the client base.”

The bank recycled 40% of underlying exposure from structured products, equating to €1.35bn nominal.

Activity with many top global asset managers more than doubled over the year, reflecting the bank’s ability to source liquidity and provide scarce balance sheet when required.

“Across the Street we’ve seen more limits in the vega notional, but we find that SG makes more balance sheet available to trade variance swaps,” said a multi-asset portfolio manager at a large asset management firm. “Their book is so big that it means you can do trades in reasonable size and they maintained their commitment in Asia even as other banks pulled out.”

The bank proved it could trade in large size with €5bn notional long-dated options on the EuroStoxx 50 and Nikkei 225 for a UK insurer.

In a year of heightened political risk, hybrids offered a cost-effective hedge. Ahead of November’s US election, the bank traded a US$200,000 vega notional variance swap spread that saw a European investment firm take a short position in S&P 500 variance versus a long position on 10-year US rates variance.

The Brexit referendum, meanwhile, triggered over €1bn notional in contingent options that played negative correlation between the euro and European equities, for a 70% discount over vanilla hedges.

Commodity consolidation

When oil slumped to a 12-year low at the start of the year, it became clear that 2016 would be a rollercoaster for commodity businesses.

“When you get into this environment, clients are focused on survival,” said Jonathan Whitehead, global head of commodities. “Our deal pipeline might be smaller but a significantly higher proportion of deals involve hedging and a significantly higher proportion of them are getting done.”

Trophy deals included a US$150m floating pre-paid forward for Norilsk Nickel that gave the client flexibility over which precious metal to deliver. The bank’s hedging capabilities also nailed a lead arranger role on a term loan for a Canada-based gold exploration company.

SG was at the forefront of a cautious hedge fund return to the asset class, enticing investors with innovative trades such as dynamic oil indices that switch between refined products and crude, depending on the shape of the futures curve.

To see the digital version of this review, please click here.

To purchase printed copies or a PDF of this review, please email gloria.balbastro@tr.com

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