Structured notes get funkier amid global yield drought

IFR 2297 24 August to 30 August 2019
5 min read
Ed Clark, Christopher Whittall

The mountain of negative yielding debt in financial markets is encouraging a growing number of European insurance companies to buy a new breed of structured note that uses greater levels of financial engineering to juice returns.

Issuance of notes linked to so-called constant-maturity forwards has hit almost €2bn since the product first appeared late last year, according to data provided by Credit Agricole, raising the prospect that such products could become the new standard in this market.

The demand for the notes from continental insurers, who typically buy government bonds to match their long-dated liabilities, comes as yields across the globe have plumbed new depths. Roughly 30% of the global tradable bond universe, or US$16.7trn of debt, now has a negative yield, according to JP Morgan.

“The philosophy of this is ultimately to get better yield and coupon in an environment where a lot of insurers and investors are desperate for returns,” said Kokou Agbo-Bloua, global head of flow strategy and solutions at Societe Generale.

For years, French insurance companies in particular have favoured notes with payouts linked to a type of derivative called a constant-maturity swap to match their liabilities.

The floating portion of a CMS trade doesn’t track a short-dated lending rate like Libor as in a standard interest-rate swap, but instead is recalibrated every few months against a fixed-rate security such as a government bond.

That has become less attractive in a world where vast swathes of the government bond market yield less than zero. Ten-year French government bonds yield around -0.3% currently, while the 10-year German yield is about -0.6%.

That has left investors wanting a positive yield to look for other options, such as buying structured notes with a beefed up coupon linked to the 10-year CMS rate starting in 10-years’ time, with a cap and a floor. That means the notes will only pay out as long as the 10-year CMS rate stays within a certain range. If the rate goes outside that range, the coupon isn’t paid.

“You can’t compete with the coupon that the 10-year 10-year will give you today relative to 10-year CMS. It’s clearly an innovation,” said Agbo-Bloua.

“Whether it becomes the new standard or not depends on how long negative rates stay in Europe and how long the ECB continues with its policy,” he added.


Credit Agricole first originated a constant maturity forward note late last year. In November, the French bank sold a €6m 12-year note, following it up with a €100m 20-year note it arranged for the European Bank for Reconstruction & Development a few days later. So far, Credit Agricole has arranged over a quarter of the roughly €2bn of notes sold so far.

The number of other banks arranging the products has steadily grown this year to 13, including Bank of America Merrill Lynch, BNP Paribas, HSBC and JP Morgan, according to the Credit Agricole data.

The investor base has also broadened, with insurance companies in Belgium, Italy and Spain also showing interest, according to a banker active in the structure.

It “is the best performing rate among available rates,” the banker said, adding that demand for other types of CMS rate has dropped off sharply.

“It has almost replaced the other indexations in the structured space,” the banker said.

Indexing a forward rate and paying a coupon based on it can generate much meatier payouts than using the spot rate. The 10-year point is typically the maximum level after which the curve starts to slope downward, the banker said, providing investors with the highest returns possible.

While listed issues have totalled around €2bn since the product’s emergence last year, bankers say there have also been unlisted trades and restructurings of existing transactions. Initially, medium-term notes were the format of choice for forward-starting CMS, with 17 of the first 18 trades using MTN documentation.

But of the €775m sold since the start of May, all but one €150m 15-year note have been repacks, the majority of which have been issued by the multi-dealer platform Spire.

The average ticket size is also on the rise. Trades closed between April and August have had an average size of over €81m, while those printed prior came in at under €60m.