Equity derivatives house of the year: UBS

Turbulent equity markets, particularly in the first half of 2019, have not made it easy for product structurers, many of which have been forced to rethink their business models and scale back operations in light of shifting client sentiment. Against this backdrop, UBS has reinforced its position as a leading equities powerhouse in Asia, seeking out new innovative products to best meet client needs and support the evolution of markets across the region.

Take Korea, for example. Sharp declines in Asian stock markets this year have caused widespread hedging losses from Korean equity-linked structures, and resulted in at least one large global player pulling back from the market. But UBS remains committed to Korea for the long term and has worked hard to overcome shortfalls in the market, in a way that epitomises the Swiss bank’s approach throughout Asia.

“UBS tries very hard to innovate, but they recognise that not every new thing will work. New products have to be in tune with what the market wants and I think the bank has a very good feel for this,” says the head of derivatives at a local Korean securities house.

One of the recent launches that the derivatives head is particularly excited about is a new leveraged index that attempts to replicate Hang Seng China Enterprise Index. This index – which was launched April 13, in collaboration with Hang Seng – attempts to overcome some of the failings that have been seen over the past few years in autocallable structures linked to the HSCEI index.

“In light of the regulator’s concerns that the autocall market is overly dependent on the HSCEI, we thought it made sense to create an alternative index. While market movements and volatility in the new index remain similar to those in the HSCEI, it is better positioned to deal with market shocks,” says Bilal Al-Ali, head of equity structured sales at UBS.

The index, which offers 25% leverage on the Hang Seng Index, was launched as a yield enhancement tool. This forced UBS to pay particular attention to the pricing. The Korean autocall market is pretty cut-throat, with clients often habitually demanding aggressive returns. Through clever engineering, UBS was able not only to construct an alternative index for autocall products but one that also delivered coupon payments between 50 and 70 basis points higher than typical structures linked to the HSCEI.

UBS tries very hard to innovate, but they recognise that not every new thing will work. New products have to be in tune with what the market wants and I think the bank has a very good feel for this

head of derivatives at a Korean securities house

UBS’ clients are starting to recognise the value of using this new index rather than the HSCEI, and in the nearly three months following its launch – up until the end of July – UBS managed to sell $154 million worth of structures linked to it.

The Financial Supervisory Service (FSS), one of the local regulators, also appears to have loaned its support to the new index and has given permission for products linked to it to be publicly distributed, whereas many other bespoke products referencing indexes can only be offered to clients through private placement.

“With FSS support for public distribution, we think the index will be a great success and expect large flows to come from bank channels,” says Al-Ali.

UBS has recently teamed up with two local Korean banks to explore further possibilities on the Korean market, which could include taking the methodology behind the HSI leveraged index and using it to replicate other indexes, such as Eurostoxx, which many Korean autocall products are also heavily dependent on.

This is not the only way in which UBS has tried to change the market in Korea. The bank has also sought to break clients’ reliance on index underlyings in favour of single-name autocall products, something that dramatically fell out of favour following the collapse of Lehman Brothers in 2008. According to Al-Ali, out of the $60 billion of Korean autocall products that were written last year, more than 95% of the underlying issuance was index-based, which is in stark contrast to many other markets in Asia.

“The only country really dependent on the index autocall is Korea. In Japan, Thailand and Hong Kong the single-stock autocall is dominant. So we believe the time is right for a change,” says Al-Ali.

UBS took one of its large Korean clients over to Japan, so that it could understand how single-name autocall products worked there. Since coming back this particular client, which previously relied almost exclusively on indexed autocall products, has introduced some single-stock names into the mix. Al-Ali says that the volume of single-name autocall products that UBS is doing in Korea has significantly increased compared with last year, accounting for 30% of total revenue for the onshore team compared to just 8% in 2019.

Given that many clients still perceive single-name stocks to be riskier than indexes, UBS has been careful to only provide very safe structures, typically with 90% principal protection. This has given clients the opportunity for greater risk diversification and also allowed them to increase yields.

Elsewhere in Asia

Korea is not the only market where UBS has sought to strengthen its presence, though. All across Asia, UBS has looked at its current equities franchise and considered how it can be built upon.

In Australia – another market where the bank has been historically very strong – UBS has leveraged off its extensive onshore presence to bring some structured notes, which were being issued out of London for Australian clients, onshore. These include equity-linked notes and mutual fund-linked pay-offs. One structure that has proved particular popular this year is the ‘worst of kick-in’ goal, which guarantees 100% of capital return, providing that none of the underlyings touch the kick-in level that has been set.

Being able to structure the notes in-country offers significant benefits for onshore clients, reducing the cost of trading and allowing more favourable economies of scale. Doing things from the London branch meant that, under the terms of its banking licence, UBS was restricted to a minimum trade size per client of A$250,000 ($170,000). Now that things are being done locally UBS is able to offer a minimum trade size of A$50,000.

Clients want to participate in the upside of global markets but they don’t know where to play, so we offer an options strategy that can be packaged into a principal-protected product in China but, at the same time, doesn’t eat into cross-border investment quotas

Bilal Al-Ali, UBS

“A$250,000 represents a big investment for many individual investors. So our ability to facilitate smaller trade sizes means that we can better serve the needs of domestic clients, capture more client flow, and reduce friction in terms of execution,” says Al-Ali.

UBS has also displayed good judgement as to when to leverage off its own equities franchise, and when to team up with others in ways that can bring it fresh opportunities.

In October, the bank teamed up with CSOP Asset Management to launch new funds, in both China and Hong Kong, based on a new momentum allocation index. The structured product was two years in the making and meets the growing demand from Chinese investors for overseas investment, as the country’s economy slows and authorities restrict capital outflows. The product has been well-received by investors, and within a few months of being launched had generated $700 million assets-under-management.

“The product chimes in perfectly with current market sentiment, in particular, it addresses investor concerns about volatility in currency markets,” says Al-Ali. “Clients in China, for example, want global investments but also seek to limit currency risk. Clients want to participate in the upside of global markets but they don’t know where to play, so we offer an options strategy that can be packaged into a principal-protected product in China but, at the same time, doesn’t eat into cross-border investment quotas.”

The index, which is an excess return benchmark net of financing cost, targets an absolute positive return and consists of five sub-portfolios investing in stock and bond futures issued in developed markets including Germany, Japan and the US, as well as commodities.

One of the reasons that the product has been attracting so much interest is that it is co-branded by both UBS and CSOP, with CSOP providing the marketing as well as intelligence on the index itself to explain why it is moving up or down, and UBS retaining ownership of the index and providing the hedging for the product.

For CSOP, the partnership has worked very well and Xiaoxi Xu, the chief investment officer of CSOP’s index business, says that he has been impressed with some of the structuring behind the product.

“The structuring and the creativity that UBS has delivered this time is definitely beyond my expectations,” he says. “Being able to get the client’s attention and bring a solution to market that the client isn’t even aware is doable – as you can imagine, this clearly makes them stand out from the other investment banks.”

The agreement that CSOP has signed with UBS does not preclude the asset management firm from partnering with other banks, but Xu says that so far no other bank has been able to deliver such solutions to the market.

By continuing to innovate and seek out new opportunities in this way, UBS has been able to successfully charter a course through the turbulence that has buffeted markets over the past 12 months.

“It is no secret that this year has been challenging in terms of volatility and muted client activity but, despite the headwinds, our ability to deliver innovation and technology to clients has allowed us to dominate in terms of issuance,” says Vikesh Kotecha, head of equity derivatives at the bank. “Underscoring our status as a truly global provider of flow derivatives, we have recycled risk across various regions. Over the same period, our platform has been expanded with products now available on mobile phone apps to the most retail of clients in China. An upcoming blockchain initiative will bring further automation to clients.”