Credit Suisse prospers despite low volatility environment

Asia Risk Awards 2014: Equity Derivatives House of the Year – Credit Suisse

Brian Chan, Credit Suisse

Last year innovation was the hallmark that led Credit Suisse to success in this category. Twelve months on and the Swiss lender continues to reinvent the way equity derivatives are offered through the region to retain its crown as Asia Risk's equity derivatives house of the year.

A year ago it was hard to wipe the smiles off the faces of equity derivatives dealers as Abenomics rejuvenated Japan and dealers and investors took full advantage of the positive sentiment. This year the Japan bandwagon has slowed down and several dealers have conceded it was a difficult year as macro funds were hurt on the long Nikkei trade. Against that backdrop Credit Suisse has surpassed last year's revenue total to register another record year.

"Our business aims to perform well irrespective of the market backdrop. We offer not only products that do well in a high volatility environment, but also those that work when the market is directionless such as our structured funds and algo offerings. A diversified business portfolio has translated into another fantastic year for us," says Brian Chan, head of equity derivatives sales for Asia-Pacific at Credit Suisse in Hong Kong.

Undeniably a big contributor to being diversified and to recycling risk in a highly efficient way was the corridor variance swap. The standout product of last year, popularised by Credit Suisse, has been the talk of the Street with many competitors mimicking the structure this year. Credit Suisse has expanded the product to other Asian indexes and created a variant that provides a sweetener to hedge funds.

"We are one of a handful of banks that pursue a broad-based strategy across the region, and to achieve scale and consistency is our advantage," says Chan.

The min-max variance swap capitalises on the fact that Asian index volatility is artificially depressed by retail structured products – retail investors selling options to pick up premium. The structure goes long whichever of two indexes – such as Nikkei 225 and Eurostoxx 50 – has lower realised volatility. For the second leg, it goes short whichever of another two indexes – such as S&P 500 and FTSE 100 – has higher volatility. By always switching to the most favourable trade in the market at any particular time, it achieves a higher return, which is then passed on to clients in the form of periodic coupon payments. This is especially helpful to investors such as hedge funds who are cash poor.

According to Charles Firth, head of equity derivative structuring Asia-Pacific at Credit Suisse, the ability to incorporate more sophisticated views on volatility has been a major part of the product's appeal. With Asian volatility being relatively subdued this year while European volatility in particular rising following tensions in Russia, investors have been able to gain from the min and max functions in the form of more favourable volatility strikes, or upfront or ongoing carry.

"As we don't know upfront which index will become the lower volatility index in the ‘minimum' pair and which will become the higher volatility index in the ‘maximum' pair, we initially have hedge positions on all of the indexes, but as time goes the exposures to each will change so we have to dynamically risk-manage the product. The structure was developed following client feedback and client demand," Firth says.

Indeed, clients have been unrestrained in their praise for these structures. One London-based hedge fund manager comments on the min-max structures: "CS is wiping the floor clean with the competition."

The manager has also traded corridor variance swaps this year and says the willingness to look at different combinations such as Nikkei vs S&P 500 or HSCEI vs S&P 500 set Credit Suisse apart. "Various iterations go back and forth before you consummate a trade and often a salesman will be bored by the fifth time but we never find they are tired of adjusting the structure to suit our needs whether it be altering the corridor or rerunning the historical numbers. The approach is geared towards bringing value not just flow," he says.

Testament to the success of these risk recycling strategies, Credit Suisse has traded more than $45 million of vega with clients in Asia-Pacific and of that total non-Japan Asia now represents $25 million of vega, a substantial rise since last year.

A large Canada-based pension fund client that traded HSCEI vs S&P 500, Nikkei vs S&P 500, and Kospi vs S&P 500 corridor variance swaps with Credit Suisse was equally complimentary. "They were the first bank to offer these structures, which we found very appealing. We like buying Asian volatility versus selling S&P 500 volatility. Credit Suisse was transparent when it came to why they were offering this and performing all necessary back-testing for us. It was a triple-A service from the sales team," he says.

Credit Suisse has also been active in other hedge fund trades such as knock-out calls, outperformance options and dispersion, with one hedge fund noting that for Korean dispersion 10–15 different baskets were offered and pricing was at least half a point better than the competition "maybe because they have a better axe".

Clearly, the client has a point – generating interesting volatility trades to hedge funds comes from a strong presence in the Asian structured products market and Credit Suisse has been active in both the Japan uridashi and the Korea autocallable business again this year. According to Firth, the Swiss bank has the number one position in Japan uridashi with ¥181.7 billion ($1.8 billion) in Nikkei 225 issuance and an 8% share of the Korean autocallable business.

Algo strategies are an increasing mainstay of equity derivatives houses in Asia and Credit Suisse has registered success with its Spear Asia product. It has attracted funds of $1.25 billion during the past 12 months and the new Spear Global launched in May, already attracting more than $350 billion. "Spear has defined a new market for algo products and demand has continued to be very strong. In fact, we opted to pause sales of Spear for a period while we ensured liquidity was well managed to ensure best results for our investors," says Firth.

Credit Suisse also added a new product combining the risk appetite investable index (RAII) with its Holt proprietary index of undervalued stocks. RAII measures sentiment which often moves markets while Holt analyses fundamentals, so using both measures should cover all the bases or so the theory goes. The data backs up the concept with a 21.6% return over the past 12 months and invested funds of $1.2 billion.

In 2014, Credit Suisse developed another dynamic strategy aimed at providing stable returns across business cycles. It uses a two-step quantitative algo to choose the optimal asset allocation.

Another huge part of Credit Suisse's business relates to structured funds sold to Asian clients through the private bank channel where it has raised $4 billion over the past 12 months across 16 fund launches, including $625 million into a Japan fund. The funds include overlays such as covered calls or foreign exchange overlays.

This year the Swiss bank has also been active with corporate clients, something that showcases its broad client set for equity derivatives and something that captured a theme of the year – increased equity and company acquisition activity. One notable deal is a share swap transaction completed on Macau Legend Development shares, which allowed the chairman of the company to raise his shareholding, resulting in a positive share price momentum post announcement of +2.5% the next day.

"Credit Suisse is doing a great job of maintaining relationships that are characteristic of old-fashioned banking focused on client solutions. The team took a complex but traditional product, modified it to our situation and then showed the risk tolerance to quickly execute the deal," says Sheldon Trainor, executive director at Macau Legend and former head of Asia investment banking at Bank of America Merrill Lynch.

In Korea, Credit Suisse has offered a broader range of payoffs this year, for example coupon anytime, which gives a high coupon if all underlyings are above a given point at any time during the observation period as well as a dual knock-in that provides protection by reducing the fixed coupon before capital is at risk.

Chan sums up the strategy that appears to be paying off: "We are trying to move beyond traditional products and offer platform solutions. Clients such as asset managers look to use derivatives to manage operational, execution and implementation risks," he says. "For us, simply wrapping more esoteric payoffs and underlyings into products every year is a business model of the past."