Several years ago, at a time when investors were starting to wonder if the longest bull market in investment history might be nearing its end, BNP Paribas’s non-flow structuring team in the Asia-Pacific (Apac) region decided it was time for some new additions to the product offering.
“We were starting to see clients paying more attention to downside risk,” says Charles-Edouard Garnier, head of equity derivatives distribution sales, Asia ex-Japan.
“So, we redeveloped the product offering, focusing less on ‘one-way’ type products, and showing clients that they can achieve some diversification through non-directional market-neutral trades.”
“Because we’ve been able to introduce all these relevant solutions in a timely way, addressing different market needs, we have remained relevant to clients, rather than losing them to the benefit of other asset classes and investment vehicles.”
The market-neutral strategies rolled out in the second half of 2019 turned out to be one of the big blockbuster trades in the private-bank client space last year and into the start of 2021. For Vincent Desmarest, head of equity derivatives, global markets for Asia-Pacific, the success is but one example of BNP Paribas’s non-flow team’s enduring capacity to develop market-leading investment solutions by proactively anticipating clients’ changing needs.
The theme, he says, runs through many of the bank’s other innovations from the past year. It is evident in the deployment of artificial intelligence in its quantitative strategies, for example, and its efforts to transform sustainable investment in Apac with the launch of green growth bonds.
It also underpins the bank’s long-term focus on digitisation, thanks to which the proportion of time-consuming manual quotes now account for fewer than 1% total quotes.
“They’re constantly coming up with new ideas,” says one private bank structured products executive. “With their solution-orientated thematic analysis, innovative structured payoffs and fast turnaround on pricing, the non-flow team has been a valuable partner for many years now.”
The recent popularity of the Talisman Option – a payoff linked to the dispersion on a set of stocks – could be explained as a simple case of the right product, in the right place, at the right time.
For investors, the products offer a means to express a market-neutral view that the performance of a certain group of stocks will diverge. By investing in the products, they are essentially buying an out-of-the-money call option of the dispersion of a basket of stocks – that is to say, the average distance of the returns of individual stocks against the average return of the basket of stocks.
If well-timed, the products offer the potential for quite significant gains relative to the premium the investor pays. Furthermore, the market fallout from the Covid-19 pandemic, which caused correlations across equities to spike in the first quarter of 2020, provided investors with the perfect entry point.
“When there are crises, you will see some different sets of dispersion,” says Desmarest. “You’ll see winners and losers within sectors and between sectors. With that dynamic, you can then construct something that is more market-neutral, which comes as a nice addition to portfolios that tend to be bullish on structured products most of the time.”
When there are crises, you will see some different sets of dispersion. You’ll see winners and losers within sectors and between sectors. With that dynamic, you can then construct something that is more market-neutral
Vincent Desmarest, BNP Paribas
But, as he explains, pitching these unfamiliar products to private-bank clients is not easy. It helps to be able to construct a compelling narrative around them. BNP Paribas brought together its research and financial engineering capabilities to conceive a host of different dispersion themes, shaped around trends such as the transition to the new economy or events such as the US elections.
The Talisman Option proved advantageous for both BNP Paribas and its private-bank clients, as well as the high-net-worth and family-office clients that made large gains on their investments.
They offered private banks the chance to tap an alternative revenue stream at a time when, back in the first quarter of 2020, traditional autocall structures were not knocking-out early. Investors could take the coupon generated by those products and use it to fund the premium on the Talisman Option. That helped private banks to increase volumes, turnovers and ultimately boost profitability.
For BNP Paribas, meanwhile, the risk the products generated helped offset risks such as correlation and volatility generated by the more traditional flows managed by the bank’s trading desk. A talisman investor, for instance, is essentially buying volatility and selling correlation exposure, while the opposite is true for the buyer of an autocallable on a stock basket.
“There is also a virtue to these products from a risk management perspective,” says Desmarest. “The trades allow us to reduce market risks coming from the autocallable business on US and Asian stocks. In particular, the structures have opposite exposure to stock volatility and correlation.”
Investors’ desire for more downside protection has also driven enhancements to the bank’s market-leading multi-asset quantitative investment strategies fund offering in the past year.
These solutions, delivered in a private placement fund format, have been particularly popular with local financial institutions in Asia-Pacific since their 2018 launch. In the past year, amid mounting market uncertainty, the bank has started integrating hedging overlays into the strategies, to offer clients the flexibility to select plain or defensive versions, according to their market views.
One widely adopted overlay uses Vix futures to establish a tail-risk hedge. The trouble is that, over long periods, the cost of carry associated with such strategies can be prohibitively large – as high as 60% a year. Desmarest says it has been observed that the cost of carry tends to be highest when volatility is muted, precisely the time when the futures are not needed in the portfolio.
The solution to lower the cost of carry was to use technology to monitor the level of the Vix index continuously during the day and to adjust the exposure as required. When the Vix is low, the overlay maintains a low exposure to Vix futures for a low cost of carry. When the Vix begins to spike, the exposure to futures on the index quickly increases.
As a result, the overlay is able to offer clients a buffer of between 5% and 10% on their portfolios, at a relatively cheap average historical cost of roughly 20 basis points a year.
“Clients jumped into more defensive solutions because their risk appetite dictated that,” says Garnier.
“In managing their risk appetite, clients can move from one product to another within our range, depending on what they feel [is] relevant for the moment. Because we’ve broadened the possibilities in terms of risk profiles, we have found ourselves with a ‘stickier’ client base.”
Project Green Kangaroo
In another landmark solution, BNP Paribas deployed its structuring know-how to drive capital into sustainable investments while at the same time delivering higher returns for investors.
While investment strategies are already becoming commonplace in Europe and the US, it remains a relatively nascent practice with investors in Asia-Pacific financial markets. BNP Paribas’s structuring team in the region are making it their mission to change that.
“We’re recognised as leaders in the sustainable investment space in Europe and also globally,” says Timothy Parker, head of equity derivatives institutional sales for Asia ex-Japan.
“Our ambition with this transaction was to export that leadership from Europe to Asia.”
He says the bank decided to focus its efforts on what many regard as one of the more forward-looking markets in the region, Australia. The basic concept behind what the bank calls Project Green Kangaroo was to combine the direct impact and investment security of a green bond issuance with the potential return of a sustainable equity investment.
Feedback from clients had revealed that, while interest in green bonds was growing, the yield on the securities was insufficient for many investors. In addition, there was a lack of appealing equity solutions in the market that aim to capitalise on the transition to a low-carbon economy.
BNP Paribas solution was the issuance of an eight-year green growth bond, a note with a return linked through a packaged option on the bank’s own Australian Climate Transition (ACT) index.
“The idea of the green growth bond is that we take a traditional green bond, and, rather than delivering a small fixed yield, it is used to buy an option on a sustainable portfolio or index,” says Parker.
The index was itself an innovation. Until now, most sustainable indexes worked on an exclusion basis. Companies were divided into green or brown, and the brown companies discarded.
The ACT index is more dynamic and forward-looking. Bringing together the pioneering transition research undertaken by partner ClimateWorks Australia, the environmental, social and corporate governance (ESG) research by ISS ESG, and the quantitative expertise of Monash University, the index is designed to benefit from five different climate scenarios in Australia.
“For a single company, we look not only at the products they offer today and the way they operate today, but also how they are intending to change their business and operational processes in the future, and how that will be affected by different transition scenarios,” says Parker. “And over time, what we’re going to do is weigh those transition scenarios as they materialise.”
Project Green Kangaroo has already proved a big success for BNP Paribas and its partners. Since its launch in August 2020, three major institutional investors in Australia – QBE Insurance, Aware Super and the Clean Energy Finance Corporation – placed A$140 million (US$102 million) into the eight-year green growth bond. The proceeds from the issuance have subsequently been used to finance clean energy projects in Australia and across the world. The ACT index, meanwhile, has outperformed the Australian benchmark equity index, driving returns up to four times higher than a vanilla green bond.
Parker says that, following the success of Project Green Kangaroo, the bank has initiated similar initiatives in markets such as Japan, South-east Asia and the US.
“The ACT index is an exciting market-leading development, mobilising the increasing scale of impact investment to benefit Australian companies leading the emissions transition,” says Ian Learmonth, chief executive officer at the Clean Energy Finance Corporation.
“As the first forward-looking index in the Australian market, it gives investors the capacity to analyse the climate risk profile of their ASX portfolios. At the same time, it gives emissions-focused companies access to a greater pool of capital – a powerful incentive to accelerate decarbonisation efforts.”