It is hard to think of an event over the past 12 months that has been more significant for the Japanese markets than the decision by the Bank of Japan (BoJ) at the beginning of the year to move into negative rates territory, cutting the deposit rate to –10bp.
BNP Paribas wins this year's Japan House of the Year because of its prescience in not only being well prepared to cope with the BoJ's move but also being able to attract new business because of it. The bank has also continued to show strong commitment to the market through a reorganisation of its global markets team in the country, placing the client more at its centre.
"I clearly recall that last year we were saying: the next thing the BoJ is going to do is adopt negative interest rates in order to provide more market stimulus, since quantitative easing had already run its course," says Kyoya Okazawa, head of global markets for Japan and Korea. "By preparing ourselves to examine what would happen in case of this eventuality, we were able to effectively manage liquidity issues and the size of trades that came off the back of this."
Products that BNP Paribas had already established on the market came to the fore during this period. One particular example is a collateral exchange, which was already being used by clients to enhance the yield on their investment grade and Japanese government bond (JGB) portfolios. This is done through combining reverse repos on investment-grade securities with repos on government bonds (or other categories of market instruments depending on precise client needs).
BNP Paribas launched this programme around 2009 to help with meeting certain requirements of the Basel III framework – notably the liquidity coverage ratio and the net stable funding ratio. Both of these reward banks which fund themselves through high-quality liquid assets, so paying a fee to get rid of some lower-grade assets made sense for the French bank. The clients were happy, too, because of the yield pick-up.
BNP Paribas says it recorded a surge in demand for these kinds of transactions following the negative interest rate decision.
While repos and reverse repos are conceptually fairly simple, the innovation in what BNP Paribas has been doing compared to some of its competitors – including many large trust banks and custodians – comes in the pricing.
"Many other providers run this service as an interbank business, with transactions that are callable daily. Pricing this is very different to doing the pricing for a one-year repo, borrowing Japanese Treasuries against Japanese equity, for example," says Manoj Rangwani, head of international yen rates sales.
A number of different components add to the complexity of the pricing model, which has been implemented onshore in Japan. First, BNP Paribas needs to be able to price a one-year repo on the Treasury, which is not always easy to come by in the current market. The bank also needs to be able to price a one-year repo on Japan's Nikkei equity index, and then to understand how movements in the market might affect this price relationship.
Pricing becomes even more complex when considering the range of tenors that BNP Paribas now offers. The bank began with a one-year offering, but now frequently does transactions up to five years. The French bank has even managed to persuade clients to lend cash against equity for 10 years.
BNP Paribas' pricing model also factors in the haircut the bank needs to take, which can go up to 10%.
"We have a weekly pricing grid across all asset classes, so equities are crossed with JGBs, credit, a mix of cash and bonds. Calculating the haircut is important because it will impact the fee that clients pay," says Hiroyuki Kazama, head of structuring for global markets in Japan.
BNP Paribas has also continued to support Japan's variable annuity market, which remains an important component of the insurance segment in the country. Rather than simply provide basic hedging facilities on variable annuity products, BNP Paribas has brought to the market a solution where it actively manages much of the risk inherent in the product – and this has earned the bank loyalty among its clients.
With a standard variable annuity solution, banks often provide hedging to insurers by selling them a put on a fund made up of variable annuity premiums. But this requires the insurance company to take counterparty risk on the bank – often in extremely large sizes – which it is not always comfortable with. This is why BNP Paribas has proposed an alternative structure.
"With our solution, the insurer guarantees whatever capital needs to be returned to the client. For the rest, we find a mechanism to create a leverage effect on the book and manage the risky part as part of our hedging strategy," says Majdi Jemel, head of financial products for global markets, Japan.
But BNP Paribas remains uncomfortable with mortality risk, which it tries to offload to reinsurers as quickly as possible. Fortunately, this is a risk that reinsurance companies tend to be fond of and so BNP Paribas can usually get an attractive price for it. The only challenge is to separate the mortgage risk from other financial risk, which BNP Paribas handles, and that requires some clever financial engineering to distil mortality risk to almost 100% purity, before offloading it.
BNP Paribas received recognition for its variable annuity solutions when it fought off six other banks to win a deal for an investment solution that would go into the special account portion of the variable annuity.
Besides having a strong track record, BNP Paribas believes it was chosen because it didn't just optimise the strategy based on past performance of markets, but looked ahead to see if such performance would also be replicated in the years ahead.
"If you have a product for 10–20 years, it is important to ask the question: can we generate the same performance as in the past or was there a particular characteristic of the market that helped with the performance of the past?" says Jemel. "What is more – and this is critical – we need to make sure that the mechanism behind the algorithm is simple enough for the ordinary person to understand it."
The week on Risk.net, February 10-16, 2018Receive this by email