Deal of the year: Societe Generale

With Chinese equities significantly down last year, a pension fund in South Korea was keen to get exposure to the market. But, being a pension fund, it had a limit to the risk that it could take on.

“We spent a long time discussing with the client how we could provide them with a safe product that would generate as much return as possible, whilst also minimising the risk that we were taking on our books,” said Olivier Renoux, Societe Generale Corporate and Investment Banking’s head of equity and quantitative investment strategies (QIS) structuring for Asia.

The eventual product that SG came out with was a 15-year range accrual note that referenced two underlyings: the spread between the 30-year and two-year yield on US swap rates (which is a very popular underlying for investors in the country) and a basket of futures based on China stocks traded in Hong Kong. The product was not capital-protected, and so SG also introduced a knock-in barrier that would protect the client up to a certain level.

SG also incorporated two other important features into the product.

One was a dynamic trading mechanism so that volatility within the structure would never go above 25%. This required a high level of structuring (the details of which SG are reluctant to publicly disclose), so that when volatility did spike, as it has done a few times during the Covid-19 pandemic, the vol target could still be managed.

The other was the inclusion of a 3.5% fixed dividend in the product, which allowed SG to offer the client an even higher coupon. The challenge here was in managing the implied dividend risk in the market. Again, this is where SG’s structuring expertise came in: by using a fixed-dividend mechanism, the bank was able to remove the uncertainty on dividend levels.

“We take pride in both of these mechanisms, because it would not be possible to add either of these features into the product without the structuring and trading expertise that we have, as well as the long-term relationships we have fostered with our clients,” says Renoux.

The trading expertise in particular allows the French bank to be more aggressive on price.

“If we can reduce our volatility risk, then, at the end of the day, we can offer more aggressive pricing for the client,” he tells Risk.net.

“The same is true in the fixed dividend space. It is important to be able to anticipate what the implied fixed dividends will be if we are going to be able to manage this risk correctly.”

By structuring the product in this way, SG was able to offer a highly attractive coupon of more than 9%.

The challenge of selling

The other challenging part of the product was to be able to sell it to the client itself.

“We are a derivatives house – we know how to structure and to manage this stuff. But, from the client’s perspective, it’s really not easy to understand how it works,” says Renoux.

“This is where the sales pitch came in. This required several months of working with the client, and helping them understand why the vol target will help them, and why it will help them get a higher return.”

“In structured products, high risk/high return is fairly normal. But with this product, we are able to offer decent returns in a far safer structure.”

SG has so far done two clips of this particular structure with the same client, one in March and the other in June. Both clips were for $15 million notional.

The bank is now looking at whether it can put on similar trades with other banks.

Having already structured this product for the Korean market should make it slightly easier to sell similar solutions to other clients, both inside and outside of Korea. However, as Renoux points out, every client is different – and this may slow down the speed at which the product can be replicated.

“We have to take a different approach for each client. Every situation is different. We have to have a very accurate understanding of what their portfolio looks like and what their risk appetite is,” he says.

“But this is where our sales team, and the relationship that we have with our clients, comes in.”

Renoux thinks that the product could be highly relevant in Japan and China, given the needs of pension funds in these two markets. SG is actively exploring the feasibility of developing a Nikkei version of the product at the moment.

“This isn’t going to be immediate. Rome wasn’t built in day, so it’s going to take time. But we are very committed to expanding in these markets,” he tells Risk.net.