Buy-side Awards 2016
Societe Generale also won Risk.net's award for best bank for asset managers.
Times have been tough for banks in their dealings with the buy side. Lending via prime brokerage and the repurchase agreement (repo) markets has been constrained as banks have deleveraged. Insurers facing Solvency II may tend to prefer simplicity over complex products.
In spite of this, French bank Societe Generale (SocGen) has found ways to grow its risk solutions business across all client segments.
With repo becoming costlier, the bank has set up a unit to take cash off the balance sheets of asset managers, medium-sized insurers and corporates using structured notes. It is offering cheaper ways to hedge political events such as the British referendum decision on June 23 to leave the European Union ('Brexit'), while working to recycle volatility risks from its structured products business to hedge funds.
It is offering fund managers ways to increase their fund leverage beyond 40 Act limits using credit lines. It is helping insurers deal with the pressure of offering guaranteed returns to policyholders. Meanwhile, the bank has put its algorithm ‘factory' at the disposal of BlackRock, Pimco and Amundi, among other buy-siders seeking to more efficiently execute cash equities.
Codeis is the bank's solution to provide returns for cash-rich buy-side firms priced out of the repo markets. Total return swaps (TRS) have proved a cheaper means of funding for SocGen from cash-rich customers, but mass take-up is constrained.
"We are trying to develop the TRS market, but the number of clients that can do TRS [is] today effectively limited to big banks and a few big insurance companies," says Eric Viet, London-based head of sovereigns and financial institutions for SocGen's financial engineering team.
The bank, therefore, set up Codeis, a segregated unit with which SocGen trades TRSs. The unit then sells notes to investors. On redemption, Codeis receives a premium from the bank, which it pays to investors. The bank has financed €5 billion ($5.3 billion) of notes since the vehicle's launch in August 2015.
"[The idea is] to wrap in a notes format all the kind of TRS, collateralised trades, securities lending, pledged agreement trades that can be done on the market between dealers. With this product, we wanted to reach all kinds of clients. We [have] sold it to corporates, to asset managers, insurers... None of them were set up to be able to handle TRS," says Xavier Chartres, Paris-based head of cross-asset financing at SocGen.
"If they buy a note, there is no documentation or Isda, there is no management of collateral during the life of a trade – so from a pure operational point of view, it's a very simple transaction... As a consequence, it's viable to almost any investor," he says.
It has the additional benefit that it reduces SocGen's leverage ratio and net stable funding ratio, designed to restrict bank leverage and short-term funding respectively, as TRSs are lighter on the balance sheet than repo.
"If we finance ourselves with another customer that is cash-rich, we have effectively one repo and a reverse repo transaction with two customers. From a leverage ratio [perspective], we have two transactions. If we can finance the transaction with a TRS... by nature of the derivative, the leverage ratio and the net stable funding ratio are going to be calculated on the mark-to-market of the transaction, which at t-zero is zero," says Viet.
"We can also do a TRS that resets on a quarterly basis, which means we have an effective cash settlement of the value of the TRS every quarter. Therefore, at each quarter, the mark-to-market of the TRS is back to zero," he says.
[The idea is] to wrap in a notes format all the kind of TRS, collateralised trades, securities lending, pledged agreement trades that can be done on the market between dealers. With this product, we wanted to reach all kinds of clients. We [have] sold it to corporates, to asset managers, insurers... None of them were set up to be able to handle TRS
Xavier Chartres, Societe Generale
The leverage ratio is also driving SocGen to sell off about 40% of its volatility risk attached to its structured products book. Over the past year, the bank has sold hedge funds €10 million of vega in convexity risks (the risk of higher volatility during a crash), €2.5 million vega in cross-class correlation risk and €1 million in cross-equity correlation risks. This translates to about €1.35 billion nominal risk transfer, the team thinks.
"It used to be volatility hedge funds [buying vega]... but we see more and more interest from diversified macro funds, suffering so much from the current environment that they cannot afford to neglect some quant trades that are very profitable," says Stephane Mattatia, Paris-based head of SocGen's global macro group.
The bank devises a number of ways to help hedge funds profit from quant trends, while offloading risk. One trade takes advantage of the mean-reverting volatility phenomenon. Asset prices tend to revert to the mean over a week because of behavioural factors, and the trend can also be noted between different assets.
"If I were an option trader, if I sell an option, I would be more likely to hedge my option only every week, rather than every day, because by doing so I would be paying weekly volatility, which is slightly smaller than the daily volatility," says Mattatia.
Forex volatility spread trade
SocGen also put on one of the biggest foreign exchange volatility spread trades with a UK asset manager before Britain's EU referendum, amounting to €4 million in vega. Expecting sterling volatility to rise, the asset manager took advantage of the low €/£ implied correlation, trading the spread between a £/$ volatility swap and a €/$ volatility swap.
The bank put on about €1 billion of pre-referendum hedges in notional terms, devising ways to hedge at a 70% discount to vanilla options. Asset managers could buy a six-month put on European or German equities, on condition that €/$ is lower at maturity. They could also buy an option paying out a 10x premium if gold rises 5% and £/$ falls 5%.
Mattatia thinks hedging political events seems to have become more popular, particularly among hedge funds and asset managers that traditionally have avoided geopolitical bets. Brexit hedges put on by banks before June 23 were estimated to be about €5 billion.
Elsewhere, the bank has partnered with French insurer CNP Assurances to launch Flexi Sérénité, a product designed to offer policyholders guarantees even when yields are low, but also encourage customers to migrate to unit-linked investments.
In the French insurance market, capital guarantees are popular, but many products simply guarantee the capital at maturity and a bonus for the first few years – guarantees over an eight-year tenor are seldom available. "It's very expensive from a Solvency II point of view. Effectively, the insurance company takes all the risk: principal and return risk on assets, and in case of lapse and death," says Viet.
"Insurance companies are trying to move into unit-linked [products]. But unit-linked is clearly not very popular in France. France is not a country with a strong equity culture."
Many unit-linked structures with capital guarantees safeguard 90% of the capital, but not 100%.
"It's proving hard for insurers to sell managed funds in unit-linked to retail investors. Equity funds are still deemed very risky... and diversified funds have disappointed compared to what was promised," says Jean-François Mastrangelo, co-head of pricing and development for global markets.
"In terms of alternatives, what we have seen is structured products, formula-based unit-linked with guarantees. That is very hard for some clients, as they do not want formulas. A second [solution] is the more variable annuities type of business, which are managed funds in unit-linked with guarantees on top. It has developed a lot in Japan. In Europe, it is still slow," he says.
Flexi Sérénité guarantees 100% of the original investment at maturity, which is two to five years. It comprises a put option on the unit-linked portfolio at 95% strike – the 5% is made up by a guaranteed yield portfolio, which will return enough to cover the possible unit-linked losses.
Insurers can adjust the riskiness of their portfolio, with 50–75% being guaranteed yield and one-half to one-quarter being risky asset exposure. The guarantee can also be lowered to 98% or 95%.
SocGen has also spent the last year optimising credit risks and yield for insurers faced with Solvency II. The bank has sold €1 billion of callable bond repackaged structures over a nine-month period. Insurers sell their government bonds to SocGen, which sells them Solvency II-friendly notes with the same credit risk exposure and long-term calls.
It used to be volatility hedge funds [buying vega]... but we see more and more interest from diversified macro funds, suffering so much from the current environment that they cannot afford to neglect some quant trades that are very profitable
Stephane Mattatia, Societe Generale
In one case, the bank took on another bank's counterparty risk of the French railway company RFF, temporarily hedged the position and sold an insurer a repackaged credit-linked note. The team say they expect credit value adjustment repacks to be "highly scalable" in future.
The bank has also helped portfolio managers increase the leverage of their closed-end funds without violating 40 Act rules. SocGen provided a $640 million credit line and a $140 million repo line to one fund run by US asset manager Nuveen, raising its leverage to 40%. The bank has the first claim on collateral assets, held in separate custody accounts.
The bank has also now integrated its brokerage Newedge into its main investment bank and has started to offer its cash equity execution services to bigger buy-side firms such as Pimco and BlackRock. It provides access to its electronic futures platform and transaction cost analysis.
Time-weighted averages used to dominate in futures trading, but now established firms want access to more sophisticated trading strategies, believes Jean-Gael Pouliquen, sector head for SocGen's asset management programme: "In the past, you were saying, depending on the size, we will buy 50, 100 contracts every 30 seconds... You were not looking at different things such as volumes, volatility and all this."
Investor pressures to lower execution costs have been among the forces leading to more focus on execution algorithms, Pouliquen says: "Execution can be the difference between loss-making and profit-making."
The week on Risk.net, December 2–8, 2017Receive this by email