Credit Derivatives House: JP Morgan

Equity derivative businesses went into 2016 with a mountain to climb as a turbulent start put the previous year’s record structured products revenues out of reach. For BNP Paribas – a bank that spent recent years integrating sizeable structured products acquisitions – the focus shifted towards a more balanced model to promote stable returns. A diversification effort had been under way since early 2015, when equities, commodities and fixed income were consolidated into a global markets unit. In equity derivatives, the bank removed product lines and combined flow and structured operations to address complex client needs through a full range of solutions stretching from low-touch delta one flow activities, to highly bespoke quantitative investment strategies, with an unparalleled commitment to sustainable investment themes. “It has been a challenging year for underlying activity, but all of our efforts are paying off and the franchise is more diversified,” said Nicolas Marque, head of equity derivatives at BNPP. “We’re now much stronger in flow and we’ve seen big growth in the algo business. The consistency of our strategy is going up.” Distribution revenues were down 25% – in line with market trends – but the bank offset some of those reductions with improved institutional flow and big corporate gains. “This year, we moved away from a macro agenda to one where there’s little or no conviction at all. So the fact that our institutional business is up versus last year is quite exceptional,” said Emmanuel Dray, head of institutional sales at BNPP. “On our key initiatives we delivered, but there’s still tremendous room for improvement.” A three-pillared flow investment strategy encompassing capital commitment, tailored content and robust market-making infrastructure bore fruit. The bank printed some of the year’s trophy trades, including the largest dispersion swap to-date, for US$20m vega notional, traded with a US asset manager. Highlighting improved traction with US clients, the bank traded US$400m of delta one custom baskets on the share buyback theme. “Our market share with US asset managers more than doubled and it makes a big difference as just 10bp of US market share is a game-changer,” said Marque. “Today, we’re making more money from the corporate derivatives business in the US than in France. For a bank like BNP Paribas that’s a big change.” In listed markets, the bank retained a leading position across EuroStoxx 50 products, including dividend futures, and ranked number one for the CME’s new S&P 500 dividend futures by mid-year. BNPP worked closely with Eurex in designing a listed version of equity total return swaps, which enable investors to trade implied equity repo without incurring uncleared swaps margin. The bank addressed its own collateral requirements and optimised inventory by printing more than US$10bn in full flex collateral trades. The trades see clients receive a mixed pool of assets including equities, convertible bonds, ETFs and structured notes – according to the bank’s needs – in return for yield enhancement. In its Theam fund business, BNPP collected almost €500m in the Equity Europe Income Defensive quant strategy, offering insurers capital-efficient investments from a Solvency II perspective. New clients brought on to the insurance platform included Nippon Life, one of Japan’s largest insurers, as part of an expansion of the variable annuity business. With a strategy geared towards sustainability, BNPP cemented its position as a leader in environmental, social and governance themes. In November 2015, the bank partnered with 12 French institutional investors to launch Tera Neva, a sustainable investment platform supporting bespoke products that combine financial performance with impact investing. “Sustainability isn’t just part of our product range, it’s something we put at the top of our entire product range,” said Marque. “The sustainability theme was once perceived as a nice thing to have if you

Citigroup expanded its global interest rate derivatives franchise during 2016, tightening its grip on flow business and adding an array of innovative structures to service client needs. Bouts of volatility in 2016, including January’s stock market sell-off, the UK’s vote to the leave the EU and the surprise election of Donald Trump, created challenges for some banks but also offered opportunities arising from increased client activity. Citigroup was notable for its consistent pricing and willingness to fill big tickets in automated and over-the-counter formats. In the process the bank increased its share of the US vanilla swaps market to 18%, the highest ever recorded for a single dealer in the product. “We have grown our share of the US interest rates swaps market over the past two years,” said Andrew Morton, the bank’s global head of interest rates. “The key has been our commitment to a full service model, focused on efficient recycling of risk.” Citigroup’s ability to service client demands across the full range of products and geographies was testament to the bank’s ability to take on positions in one part of its franchise and find netting opportunities elsewhere in its portfolio, reducing its leverage and risk exposure. It also prioritised clearing, helping clients achieve cross-product margining and reduce collateral liabilities. That was crucial in an environment in which capital requirements such as the Basel III leverage ratio have had a punitive impact on interest rate swap businesses, with dealers particularly exposed to heavy charges for longer-dated exposures and where in-the-money trades were collateralised with securities rather than cash. The impact of higher capital burdens meant banks were required to make hard-headed decisions about rates units, in many cases widening bid-offer spreads and hiking prices in areas such as repo and securities financing. Some, meanwhile, backed away altogether. The prize for those that remained was healthy returns in a busy third quarter, which put some rates businesses on course for their best year since 2012. “We are full service and we have maintained our presence around the globe, from Australia to Japan to Canada,” said Morton. “We do every single product with as much consistency as humanly possible and make sure we offer 24-hour pricing in flow solutions like dollar swaps.” At the same time, the bank focused on reducing its cost base, encouraging clients to transact through its Velocity platform, the transaction pricer described by one client as “above and beyond any other platform in competition”. A particular hit with clients was Velocity’s vanilla option pricer, which enabled them to dial up volatility scenarios and structures to create bespoke risk exposures and model portfolio impacts. “Our ability to accurately value complex risks meant we were able to grow market share and enter new markets,” said Morton. One area of particular focus over the past year has been the sterling business, he said, where the bank has become one of the biggest players in exotics such as spread options and mid-curve trades. Citigroup was also successful in structuring innovative financing solutions, for example using structured synthetics to open access to non-US dollar markets. In one example a heavily leveraged client needed to raise euro funding, but did not have access to euro-region markets. The client’s high level of debt meant it had limited capacity to generate credit lines necessary for cross-currency swaps. Citigroup advised the company to create swap capacity through a tailored multi-threshold CSA, and combine US dollar-denominated issuance out of its European subsidiary with a cross-currency swap, enabling it to issue 10-year euro-denominated debt synthetically. One of the key trends of post-crisis derivatives markets has been the willingness of banks to share risk and to seek out pockets of value where other banks are in a position to offer better pricing. The result was a

In the wake of the global financial crisis, Citigroup made a bold call to maintain its commitment to commodities. The 2009 sale of its commodity trading unit, Phibro, created opportunities for expansion in financing and hedging activities as others embarked on a long and drawn-out retreat. By 2015 the call had paid off. After four years of double-digit revenue growth, the bank had cemented its position in the top tier. But far from simply reaping early mover advantage, Citi proved in 2016 that its business model could weather storms. “What was really important in 2016 was delivering the revenues despite the market being much more challenging and proving that this is a robust business,” said Jose Cogolludo, global head of commodity sales at Citigroup. “This year was all about consolidation of performance. We really felt we had achieved our ambitions in 2015, but we knew we needed to repeat that again.” Historically tilted to North American gas and power, Citi’s commodity fortunes seemed bleak during the first quarter as crude oil prices fell to decade lows. Principal commodity trading revenue was cut in half for the first quarter compared with a record 2015, and was down 29% for the first three quarters. But client activity was more buoyant than ever as diversification and big-ticket trades put overall commodity revenues back on track to equal or beat 2015. “We’ve really changed our mentality to go for bigger trades, which has compensated a really challenging year in flow,” said Cogolludo. “Flow keeps you in the market and without it you can probably only grow so big, but when markets are quiet flow goes away.” Citi worked on some of the largest transactions of the year, including over-the-counter gold trades, sovereign hedging programmes and physical power hedges for wind farms, using balance sheet strength, structuring expertise and flow capabilities to trade in volume, tenor and illiquid markets across multiple products. Precious metals expansion was key to that success. The bank became a full market-making member at the London Bullion Market Association at the start of the year and built its central bank activities to more than US$4bn. On its Citi Velocity e-trading platform, the bank offered clients instant access to precious metals price-making and liquidity. By October, client revenues from metals operations had outstripped the oil business. Diversification was also seen in the geographic breakdown. In 2013, nine of the bank’s top 10 commodity clients were based in North America. By 2016 that was down to just four, with clients from Europe and Latin America making up the remainder, while further traction was gained with Asian clients. “We’ve added a new dimension to our business this year,” said Cogolludo. “We’re now a top-tier player in the metals business and we feel we have a much more robust business, with growing revenues in Europe and Asia, and less reliance on North America.” Metals and mining were behind some of the bank’s big-ticket wins. One transaction saw the bank make its first foray into iron ore and metallurgical coking coal – borrowing structuring solutions from a planned oil refinery transaction. The deal saw the bank hold title to the commodities, offering credit enhancement and financing for the client. “Innovative financing solutions fit well with what Citi is about,” said Cogolludo. “These deals are exactly what we’re supposed to be doing – providing financing and promoting growth.” The bank’s metals ambitions may be crucial for continued growth as regulatory changes are currently in the works, which will pile hefty capital charges on polluting energy products. In addition, the bank also sees agriculture, bulks and the investor business as core growth areas in the years ahead. In the oil business, the bank was able to offer an array of financing solutions from simple repos to more complex full working capital solutions. Two separate trades saw the bank purchase oil in the market to sell to refiners

The US$750m perpetual non-call five securities was priced on August 30 at 3.6%, comfortably beating the 4.25% record set earlier in the year by ICBC (Asia). To put that in context, Europe-based lenders HSBC and Societe Generale had AT1s callable in 2020 trading at 5.43% and 8.45% at the time. Asian investors were key to the Reg S deal’s success – as they were in many bank capital issues during the year. But while state-owned ICBC benefits from the support of cash-rich government-linked investors, DBS needed to convince a broad range of buyers that a private-sector, Singaporean bank (albeit one owned to a large degree by government entities) warranted a tighter yield than even China’s biggest lender. It took DBS and its bankers a series of gutsy calls to break through the 4% threshold, and even syndicate bankers on the deal had their doubts at first. However, the leads were confident they could find demand for a sub-4% AT1 from Asian investors who had participated in similar issues from Chinese banks. They also correctly judged that investors were hungry for yield and willing to play even during the summer season, justifying a print ahead of an expected September rush. Those bets paid off handsomely. Even though initial price guidance at 4% was already a record low coupon, DBS was able to shave off another 40bp from the kick-off point. The bonds also performed well in the secondary market, trading up on the first day and holding around par by early November. DBS was sole global coordinator, and served as bookrunner with Citigroup, Deutsche Bank, HSBC and Societe Generale. “DBS was the market leader in identifying the evolving institutional investor interest for a non-Chinese Asian AT1, and has set the benchmark for all regional banks in terms of execution strategy and seizing a unique market opportunity,” said Lee-Shin Koh, a director in capital markets origination at Citigroup. Asian banks such as State Bank of India and Woori Bank wasted no time in trying to replicate DBS’s achievement, but failed to price anything through the 5% mark even with their state links. Even Australian and European issuers were said to be flabbergasted, leaving bankers scrambling for a way to do something similar and considering whether they too should be issuing AT1s only in Reg S format. 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