Currency derivatives house of the year: Deutsche Bank

Asia Risk Awards 2018

Caroline Mauron

Deutsche Bank

Over the past year, as currency volatility remained anchored well below long-term averages, investors in the $5.1 trillion-a-day global currency market have pined for trade ideas to enhance yield and curb costs.

Coming up with efficient trades or aggressive pricing was the easiest way to lure investors. The more demanding option was to come up with trade ideas that addressed the current challenges but boosted yields. In Asia, Deutsche Bank did just that.

The bank boosted collaboration between teams across asset classes to come up with solutions, such as Korean won correlation swaps that sought to benefit from surging equity-linked securities issuance in the country, foreign currency debt hedging and hybrid autocalls. The bank has rolled out data analytics and technology platforms to allow clients to automate their processes.

“Over the past year, the market has witnessed relatively low volatility and as a result, clients are looking for innovative trade ideas and to streamline operations to boost efficiency,” says Caroline Mauron, co-head of global foreign exchange for the Asia-Pacific region. “We have a long track record of our trading and structuring teams working together. More recently, we’ve really been focusing on cross-asset collaboration, so we are now increasingly working with our rates, credit and equity derivatives sales and structuring teams, which has allowed us to come up with innovative solutions.”

The JP Morgan Chase & Co FX Volatility Index, a gauge of the price swings in the currency market, averaged 7.5 points in the 12 months to May 2018. That was well below the long-term average of 10 points.

The gauge breached 9 points in August, for the first time since February and ended the month at 8.8 points, a touch below the five-year average. The measure has nudged up over the past month amid the US-China trade spat and turmoil in emerging markets.

The way Deutsche Bank approaches the business means it is well positioned to take advantage of the expected uptick in volatility, as demand for corporate hedging increases. The bank is hoping its pre-trade solutions (creating innovative investment and hedging ideas), execution (leveraging on data analytics technology to provide the best price for clients) and post-trade (offering seamless services throughout the lifecycle of the trade) will come to the fore.

Some of the most successful ideas that emerged from collaboration have come in the past year. These include two products derived from the South Korean equity-linked structured products markets. They are the forex and hybrid autocallable products and Korean won correlation swaps.

In the first half of 2018, against the backdrop of dwindling stock market returns, Deutsche Bank spotted an opportunity to launch autocallables linked to the USD KRW spot rate, either as a standalone or as a hybrid with equity or commodity underlyings.

“The interest in forex as an asset class can be ascribed to Korean investors’ need for portfolio diversification, the familiarity of the payoff and relatively low-risk structures that are mostly principal-protected,” says Mauron.

The product did not just catch the attention of retail investors and distributors, who have considered forex as a risk to avert, but competitors as well, who have launched similar products. In the future, Deutsche Bank aims to launch similar trades in other currency pairs.

The other product that stands testament to Deutsche Bank’s idea generation is the Korean won correlation swap.

Korean autocall issuance this year has already crossed $50 billion this year. Under this structure, investors typically express a bullish view on global equity indices such as S&P or Eurostoxx. The product pays a won-denominated coupon and can be redeemed early when the view is correct.

As a result of these flows, equity derivatives trading desks started building large inventories of short dollar-won volatility. This then triggered a large risk premium in long-dated won volatility, meaning the implied volatility was much higher than realised. The currency derivatives and equity derivatives desk worked closely with the equity derivatives team to come up with a structure where hedge fund clients would sell the dollar-won or euro-won correlation swap. This product allows clients to take advantage of market imbalances, while only taking limited risk, since the correlation cannot go beyond 100%.

This was an alternative to the usual method of selling dollar-won volatility, which wasn’t favoured during the Twitter spat between US president Donald Trump and North Korean leader Kim Jong-un before their historic meeting.

“This idea was very positively received, with several clients executing it in large sizes,” says Mauron. “At the same time, this enabled the trading team to source a supply of won volatility, and in turn to enable Deutsche Bank to increase its market share of autocall flows across all asset classes.”

Two hedge funds rated the product highly, and said Deutsche Bank was one of the first dealers to come up with such a solution, which not just took care of the exposure, but also allowed the funds to build positions without fear.

Another example of the collaboration and the subsequent generation of new ideas is the hedging of foreign currency debt. Typically hedging back into local currencies such as the Indonesian rupiah, Indian rupee and offshore renminbi has been expensive because of the one-way trade, so companies have selected to do partial hedges such as call spreads in order to strike a balance between protection and cost.

However, weakness in emerging market currencies has spooked corporates that are keen to bolster their defences. Deutsche Bank proposed an “option to increase protection”, where the client chooses to widen the bands on existing call spreads by paying a fixed premium within a certain period of time. Another was the refund feature, which provides a refund on paid premiums in the event that the call spread is not needed in the future. This product has also been a hit with clients.

Deutsche Bank proposed an “option to increase protection”, where the client chooses to widen the bands on existing call spreads by paying a fixed premium within a certain period of time. Another was the refund feature, which provides a refund on paid premiums in the event that the call spread is not needed in the future. This product has also been a hit with clients

The MSCI Emerging Markets Currency Index fell to the lowest level in more than a year last month as the stand-off between Turkey and US slammed the lira, which in turn dragged emerging peers lower as the contagion spread.

Deutsche Bank’s success in the currency derivatives market in the region has benefitted from the bank’s investment in technology. And it continues to invest in its currency derivatives business in the region, according to people familiar the bank’s strategy, despite announcing headcount cuts globally, aimed at slashing costs and boosting profits.

The lender’s clients are benefitting from the global launch of a new interface called Pandora. This Google-like search system makes it much easier to access the services and applications available on Autobahn in real-time. If a client types in ‘EUR/USD’, Pandora will bring up search results such as indicative price. The system provides instant access to spot liquidity, as well as swaps entry, options and order entry, which has been reduced to just one step from the previous six.

The bank also rolled out its forex workflow automation platform, Maestro, to a number of its forex prime brokerage clients across Japan and Australia, which wanted to automate their burdensome and non-return generating processes.

Maestro integrates directly into clients’ existing processes to streamline a wide variety of forex programmes and activities, which frees up the client’s time to focus on returns, instead of maintaining and rolling forex exposures after their initial trading activity.

Deutsche Bank has also rolled out products that freed hedge funds clients from negotiations over initial margining for correlation products. Forex prime brokerage desks were reluctant to support products such as correlation, citing reconciliation difficulties. Deutsche Bank’s currency prime brokerage team worked the options desks to offer that product to selected clients. With hedge fund assets looking at more and more exotic products in order to boost returns in a low-yield environment, the offering allowed Deutsche Bank’s prime brokerage to win several new mandates over the past few months.

“Today, the fundamental change in the currency derivatives markets is technology,” says Mauron. “It is evolving very quickly, and we are going through the same transition that forex spot trading went through several years ago. We were one of the first movers then, and we are now making investments to stay at the forefront of this business.”