Derivatives house of the year, Japan: BNP Paribas

Asia Risk Awards 2019

Kyoya Okazawa, BNP Paribas

Japanese institutional investors grappling with ultra-low interest rates and low volatility are moving away from traditional investments and trading to solutions that optimise risk-weighted assets.

In such challenging conditions, BNP Paribas has focused on yield-enhancing cross-asset solutions, such as quantitative investment strategies (QIS) fine-tuned for both insurers and, now increasingly, asset managers and banks. Clients in Japan call the French lender a reliable partner that has come up with timely but advanced QIS that have generally outperformed.

QIS assets under management are growing at double digits and the bank has been quick off the blocks with changing customer needs and regulatory tweaks, says Kyoya Okazawa, the head of institutional clients for Asia-Pacific and also the head of global markets for Japan and Korea.

“The market has evolved but the twin challenges of low yields and low volatility have only gone deeper,” says Okazawa. “We don’t believe – and our clients don’t believe – the Japan government bond yield curve will revive and as such the importance of QIS is increasing. Our cross-asset solutions, which benefit from an end-to-end approach, customer engagement, product development to sales have benefitted us and our customers immensely.”

BNP Paribas has applied its cross-asset mindset to its traditional distribution business and insurance solutions activities, where its teams cover all asset classes. This has allowed the firm to be nimble and adapt quickly to changing market conditions, and identify investment opportunities. It has also relied on its global pricing and trading platform – Smart Derivatives – to automatically serve clients as it manages more than 2,500 QIS strategies.

For example, in the current situation amid rich equity valuations and trade tensions between the US and China, a fully integrated platform combining all asset classes was vital to compensating for weakening products, such as the drying flows into equity auto-callable products. It was also useful as insurance companies progressively switched from market-linked solutions, such as variable annuities, to fixed income and foreign exchange products by insurance companies.

Life insurance in Japan is a huge market with a large retirement gap. A lot of long-term savings is clamouring for return due to low yields and a low volatility environment,” says Okazawa. “The need for market-linked products with some form of guarantee has been felt and we’ve successfully offered QIS solutions for variable annuities to turn into a key player in the sector.”

Variable annuities are insurance policies issued by insurance companies, which are distributed to retail investors as an alternative saving tool with a guarantee feature upon the death of the policyholder.

The ongoing low interest rates environment and regulatory changes have crimped volumes as insurance companies reviewed their variable annuity portfolio and sought alternative investment-yield sources.

The Japanese variable annuity market has logged total sales of more than €200 billion ($220 billion) since 2002 and BNP Paribas has helped life insurance companies raise more than €10 billion from 2013 to 2018.

We don’t believe – and our clients don’t believe – the Japan government bond yield curve will revive and as such the importance of QIS is increasing

Kyoya Okazawa, BNP Paribas

While the low-yield environment pushed Japanese annuity industry to turn to foreign assets to achieve targeted returns, the Japanese Financial Services Authority (FSA) issued guidance in January, instructing insurance companies and banks to spell out the currency risk embedded in foreign-denominated products and the costs associated with hedging it.

That has forced insurers to rethink investments in US or Australian dollars that have traditionally been high-yield assets. BNP Paribas was among the first to respond to the changing investment narrative.

“We’ve continued to adapt to the fast-changing conditions in the insurance market,” says Okazawa. “There are some concerns in the market on whether some networks are sophisticated to sell US dollar underlying products to retail investors. We looked at coming up with yen-denominated products and very recently launched a unit-linked product based on QIS.”

It is a delta one multi-asset yen-denominated product with no financial protection and is suitable for the current market environment.

The bank has also stepped up its presence in fixed annuity products as the market shifted. Sensing the move to fixed annuity products, the bank also came up with a hedging programme for innovative fixed annuity foreign currency products, which has been well received by clients.

In the past year, the bank has taken its QIS offerings beyond insurance to investors such as asset managers, corporates and banks.

“There is a huge need beyond insurers and retail investors for good risk control strategy in the current environment,” he says. “We’ve developed strategies either in the form or of overlays or fund format.”

Banks, especially the regional lenders in Japan have been key distributors of BNP Paribas’ variable annuity products and hence are aware of the prowess of the product, he says.

BNP Paribas took the variable annuity products’ QIS part such as multi-asset indexes to offer a solution for regional banks suffering in the low-yield environment. Over the next year, 30 trillion yen ($282.4 billion) worth of Japan government bonds (JGBs) will be redeemed and the regional banks will have to reinvest into a non-JGB asset class at a time when the US treasury yields are low and hedging costs on US dollar are expensive. Investing in euro assets also faces a similar predicament.

The 30-year US Treasury bond yield slipped below 2% for the first time ever and the 10-year Treasury note yield fell below 1.5%, to a three-year low in August as investors scurried to safety. The historic drop in long-term US bond yields came shortly after interest rates on the closely watched 10-year and two-year Treasuries inverted for the first time since 2007. The inversion of this key part of the yield curve in the last three instances has been followed by an economic recession.

The cost of hedging dollar-yen currency risk stands at about 250 basis points for Japanese investors, negating the spread that US government bonds offer over their Japanese peers. That has forced Japanese investors to reduce their hedging activity.

There is a huge need beyond insurers and retail investors for good risk control strategy in the current environment. We’ve developed strategies either in the form or of overlays or fund format

Kyoya Okazawa, BNP Paribas

“We could easily tap the opportunity as we have a strong reputation in the market,” says Okazawa. “We are stepping up our bespoke QIS solutions to meet customer needs. We have the capability to read the customer pulse and offer higher-return solutions or volatility solutions when the time is right or design solutions with or without asset classes, such as commodities for customers.”

“We are cross-selling G10 currency rate sales, equity products to boost our QIS solutions,” he says.

To help clients efficiently access these investment solutions, the bank has developed a fund-based solution that provides access to international exposure supported by local-hour execution capabilities. Thanks to this new distribution channel, BNP Paribas’ QIS assets under management in Japan exceeded 750 billion yen last year and are growing at a double-digit rate. Assets are expected to hit 1 trillion yen in 2020.

The bank believes it is just “scratching the surface” when it comes to QIS solutions for banks in Japan. There are about 500 financial institutions in Japan and less than a fifth are being served, says Okazawa.

It has already had initial success. BNP Paribas leveraged its 50-people strong global QIS solutions team to develop a new multi-asset long/short strategy specifically for Japanese investors, to address their key concern around compressing traditional risk premia.

This solution was built to cope with sudden market reversals, by adjusting positions quickly and repositioning on markets with clearer dynamics, such as forex.

From left: Frederic Cosmao, head of equity derivatives structuring, global markets, Japan; Kazuko Sawada, insurance solutions, global markets, Japan; and Tomoyuki Mori, head of distribution sales and cross-asset solutions, global markets

“This capability allowed our clients to weather the market turmoil of Q4 2018, when most financial institutional investors’ long portfolios suffered and alternative investments performed poorly,” says Okazawa.

Stocks were routed globally in the last quarter, the broader commodity index slumped on concerns over demand and fears of oversupply, while bond yields fell reflecting increased risk aversion and volatility amid continued macro uncertainty. Buffeted by such markets alternative investments logged their worst year since the global financial crisis.

Another example was the success in the fixed income space, where BNP Paribas offers both single asset-class strategies such as a rates factor strategy, as well as combined multi-factor strategies and solutions.

“We once again developed a specific product for Japanese investors, which aims to create a defensive and stable Japanese yen return profile with short durations to cope with erratic rate moves,” says Okazawa. “Such stable, income-based funds are valued by financial institutions who are looking for low risk-weighted assets, low volatility and small drawdowns. In contrast, alternative solutions like higher-yielding foreign bonds present higher risks due to the low credit spread and expansive forex hedging.”

The spread offered by BNP Paribas’ fixed income diversifier over the benchmark global bond index peaked in the fourth quarter of 2018 and has hovered near that levels so far this year.

Clients support the bank’s push and cite its QIS strengths globally, its multi-asset capabilities and ability to create bespoke solutions.

“BNP Paribas has advanced QIS strategies and created an exclusive QIS index for us for both structured note and fund distribution to clients,” says an executive at one of the largest Japanese banks. “The QIS products are well designed with features such as daily rebalancing multi-asset strategy, which can go long and also short and outperforming existing multi-asset strategies. We also do business with other investment banks but compared with those, BNP’s QIS strategy performance, quality of service and operational robustness stands out.”