Regional corporate derivatives house of the year: DBS Bank

Asia Risk Awards 2019

Wayne Ying Hua, DBS

Making a call on rates in the current environment is not easy and needs credible research and data to back the thesis to convince clients to sign up.

As corporate clients were struggling to come to terms with the shift in the rates outlook, South-east Asia’s largest lender DBS came up with solutions that identified multiple mispriced assets in the market and trades to offset disruptions from the US-China trade war. These solutions have helped its corporate clients hedge their rates risk and save cost.

The solution is an example of DBS’s corporate derivatives ability to ride out market moves with competent products that add to the bank’s presence across 10 markets in Asia-Pacific. Apart from cost reduction, the bank also initiated trading ideas to widen investor accessibility and introduced products to make inroads into China, a market of limited access to investment vehicles.

As for the corporate hedging solution, DBS’s argument went thus: the US economy was relatively strong but the rate curve, as the Fed shifted from monetary tightening to loosening inverted indicating investor fears over the longer-term health of the economy and the negativity, was leading to the market pricing excessive rate cuts. Economists are forecasting a 25-basis point cut in the federal funds rate to 2% in the next 12 months.

DBS says that negativity offers a perfect opportunity for corporate clients, with several of them agreeing with the premise and turning to the Singapore bank for hedging instruments and cost-saving ideas. Rather than running one pitch of plain vanilla interest rate swaps, DBS offered constant maturity swaps (CMS), betting the spread between two-year and 30-year CMS rates being greater than zero remains not inverted.

“For savvy clients, taking a view that the 30-year/two-year curve will not invert for a significant period of time could return up to 50bp of savings in the range accrual product against a vanilla IRS,” says James Tan, head of corporate advisory group for treasury and markets.

 He notes that client confidence with the team lies largely in the historical statistics as of 2018, where an inversion happened only for nine days since 1995 and adds the incident of two-year yields surpassing the 10-year lately does not impact client conviction.

“This goes back to our strength and quality in market research where we are able to paint a full picture of the market situation and opportunity to enable clients to make informed decisions,” he says.

This goes back to our strength and quality in market research where we are able to paint a full picture of the market situation and opportunity to enable clients to make informed decisions

James Tan, DBS Bank

In early 2019, an inversion in the Fed yield curve was spotted and the bank advised clients to switch to products linked to three-month Libor, taking the view the reference index did not go up above 3% to enjoy additional 25bp of cost saving.

Another thematic trade made last year was hedging and cost management amid the US-China trade war and the resultant depreciation of renminbi.

The transaction was designed for a mainland property investment trust listed in Hong Kong. For real estate firms operating extensively in China, the financing channels have been limited and they have resorted to raise funds from offshore markets, denominated either in Hong Kong dollars or in US dollars. Thus, the loan portfolios contrasted with their income and assets booked in yuan.

“The trust raised a concern about a currency mismatch dealing with their large outstanding syndicated loan in 2017,” says Tak Lap Leung, head of advisory sales, Greater China and head of treasury and markets in Hong Kong. “A solution balancing out hedging cost versus risk management was proposed.”

Tak Lap Leung

The Hong Kong team’s research showed the Chinese currency was unlikely to see a drastic depreciation last year. The property trust entered a capped forward trade with the bank, which meant that as long as the yuan did not weaken beyond a predefined rate, the contract payoff would equate to a fully hedged vanilla forward, but at a lower hedging cost.

“Even if the depreciation exceeds the cap rate, the partially hedged strategy still offers a subsidy for selling Hong Kong dollar and US dollar options at the upper end,” Leung says.

The bank also closely monitored foreign exchange trends on behalf of clients.

Cost-saving ideas apart, the bank made a concerted effort to offer products in China in the past year.

In mainland China, domestic companies struggle to invest overseas as outbound investment quota is needed from the country’s forex regulator and the procedures can be complicated.

Dealing with this major constraint, the bank structured an investment product with a payoff linked to foreign bonds, hoping to match the increasing demand for overseas exposure and additive yield. 

“The demand for diversifying from domestic exposure has been growing, especially when the offshore yield is more attractive,” says Wayne Ying Hua, head of advisory sales for DBS in China.

Borrowing costs in China in 2018 were about 3.5% under a loosening monetary environment, well below the 6% yield provided by some investment opportunities overseas, according to the bank’s research.

The bank transacted for a state-owned asset manager based in Chongqing, targeting to simulate the exposure to a US-dollar bond of a Chinese issuer. The notional amount of the renminbi-denominated contract was the equivalent of $60 million.

DBS also spotted the opportunity to attract clients amid the shadow banking crackdown in China as the second-largest economy looks to clean up its financial system saddled with sour loans.

The increasing scrutiny has a opened up a gateway for DBS to tap investors who previously parked assets in the non-standardised products.