May 28 (IFR) - Sales of structured products are booming again in a key region for these complex, equity-linked securities, just months after banks reported hefty losses from this kind of activity when markets slumped in late 2018.
There were US$15.6bn in new sales of equity-linked structured products out of South Korea in March and April, according to SEIBRO, the South Korean securities information portal. That’s the busiest two-month period since at least the start of 2015, according to analysis from UBS, and roughly double the combined issuance in January and February this year.
Investment banks make hundreds of millions of dollars in revenues every year selling structured equity products to retail investors throughout the world. They have long been particularly popular in Asia, where savers are attracted by the high returns.
HEADACHES But while lucrative, these exotic products can also cause major headaches for trading desks if markets take a sudden tumble. French bank Natixis booked a fourth-quarter loss of €259m, mainly related to its South Korean structured product positions after stocks sold off late last year, adding to the growing list of lenders to have blown up in that market.
That came after a surge in structured product issuance out of South Korea in the first half of 2018 with sales topping US$40bn across the market, 52% higher than the first half of 2017. The recent uptick in activity raises questions over whether banks’ equity divisions are setting themselves up for another fall further down the road.
“You have to a very disciplined approach,” said Shane Edwards, global head of structuring at UBS. “Experience is crucial; you need to learn from the past.”
REVENUE DRIVER Building complex equity-linked products and selling them to retail investors through wealth management networks forms a cornerstone of most large banks’ equity trading operations. The top 12 investment banks made US$14.4bn in equity derivatives revenues in 2018, according to analytics firm Coalition, with roughly US$2bn of that coming from structured issuance.
The most popular variant is the autocallable, a form of structured note that gives the investor a coupon payment so long as a particular stock index, or group of indices, doesn’t decline too much. When the index rises above a certain level, the product will automatically come due and the bank that sold the product makes a handsome payout to the investor. For that reason, these investments are sought after when equity markets are climbing and fixed income returns look measly - as has tended to be the case in recent years.
But managing the risks associated with these products is not straightforward for the banks that sell them. In December, a simultaneous decline in stock prices and equity volatility - an unusual, though not unprecedented, dynamic - sparked losses in some banks’ exotics books.
One senior equity derivatives banker said there are still around 15 banks jostling for structured products business.
“We have to be in that market,” the banker said, noting how popular the product is with retail investors.
Still, banks aren’t offering as aggressive prices as they were a year ago, the banker said, to give themselves more leeway to manage the risks associated with these books. RIPPLE EFFECTS The growth of the market has had knock-on effects across global equities. Investors buying autocallables effectively sell a put option and a call option to the bank that issues the product. That depresses implied volatility, or the cost of those options.
Longer-dated implied volatility on the Euro Stoxx 50 and Hang Seng China Enterprises Index - the most popular building blocks in South Korean structured products - has only been lower 7% of the time since 2005, according to UBS, despite the recent uncertainty hanging over markets. That compares with 31% for the S&P 500 and 33% for South Korea’s KOSPI, which are less popular underlyings.
That is creating opportunities for other investors.
“It’s a great time to use options” to express directional views on European stocks and indices, said Pete Clarke, global head of equity derivatives strategy at UBS.
Clarke is recommending that bullish clients replace some of their equity holdings with long-dated call options. Implementing these more defensive strategies is “as cheap as it’s ever been” in Europe, he said.
MORE TO COME The flow of structured products volumes is likely to remain strong, analysts say, as markets rebound to breach levels that would cause more autocallables to come due. That would free up room on banks’ books, encouraging them to sell more of the products.
And with bond yields sinking again this year - the 10-year Treasury yield has fallen almost one percentage point since November to 2.3% - the draw of these products is expected to prove as powerful as ever.
“Retail investors tend to come late to the party when indices are near the top,” said Edmund Shing, head of equity derivatives strategy at BNP Paribas.
Even if autocallables are not as attractive as they used to be because banks are not pricing them too aggressively, the alternative is a Treasury yield that is much lower than a year ago, Shing added.
“If you’re a private investor, [there’s little] alternative,” he said. (Reporting by Christopher Whittall)