Currency derivatives house of the year: Standard Chartered

Asia Risk Awards 2020

Mathieu Lépinay, Standard Chartered

The volatile markets during the first and second quarter this year have been challenging for corporates and institutional investors to hedge their FX exposures, especially in emerging markets currencies.

While maintaining a lead in Asian foreign exchange markets, Standard Chartered also opened new markets and invested in digital solutions to enable efficient access to liquidity for clients.

The bank launched operations in India’s special economic zone, GIFT city, in June this year – the first foreign bank to do so – as Indian regulators try to bring offshore trading onshore. In terms of e-trading, Standard Chartered launched an e-FX pricing and trade engine in Singapore, cutting latency for 130 currencies and more than 5,000 currency pairs in spots, forwards, swaps, and NDFs. 

As interest rates in developed markets stay near zero, the bank is leveraging its unique position and footprint to provide emerging market hedging in frontier markets for yield-seeking investors.

“In the second part of last year everything was pretty boring – low volatility, tight credit spreads, and very competitive businesses – so the differentiation came from optimisation, automation and packaging,” says Mathieu Lépinay, global head of macro structuring public side at Standard Chartered. “We have become used to that over the past 10 years, but this completely changed earlier this year, with extreme volatility making a marked comeback.”

The panic in the market meant that clients were desperate to increase liquidity and reduce costs.

“The table was flipped compared to late last year, where any corporates could call five banks and get the tightest price possible,” says Lépinay. “In the first two quarters of the year it really changed. They would call five banks and be lucky if one of them picks up the phone and agrees to do the transaction in the midst of heightened credit risk and disappearing liquidity.”

“The key challenge was to capture the value from market dislocations within the constraints of limited liquidity and credit appetite,” Lépinay adds.

Standard Chartered has been able to offer and transact hedging solutions even when the market was volatile, providing liquidity and competitive pricing.

Execution quality

One of the hedging solutions it offered to a Hong Kong-based asset manager client has demonstrated the bank’s capability to warehouse risk with competitive pricing, even during volatile times.

The client, a financing platform of a Chinese state-owned enterprise in Hong Kong, needed to hedge its net liability in US dollars as its balance sheet grew and market uncertainties rose in the city.

“One of the main functions [of the firm] is to raise capital in both debt and equity markets, and use the capital raised in investments in accordance with its mandates,” the client says. “It so happens to us that a lot of our investments with the capital we’ve raised are Hong Kong dollar-denominated, while other investments are, of course, Chinese yuan-denominated. Most of the capital raised is through bond issuances and denominated in the US dollar.”

The asset manager says its risk between the Chinese yuan and Hong Kong dollar has usually been well-managed, but the need to hedge between the two currencies is growing.

“We used to assume that with the linked exchange rate system, we should be okay between HKD and USD provided our balance sheet stayed under $10 billion,” says the client. “And then we realised the gains and losses from HKD/USD exchange fluctuations – within the 7.75-7.85 band – would easily amount to a couple of hundred million HKD. So we realised there is a genuine need to hedge.” 

Standard Chartered executed a total $3 billion worth of USD/HKD capped forwards for the client, on the back of a balance sheet hedging program during the first quarter this year. The client says it is satisfied with the hedging solution and execution quality.

“It’s been a great experience. Our relationship manager is very helpful and responsive in linking with the trading desk,” the client says. “On the execution side, there has been no discrepancy between quoting price and volume versus succeed execution, meaning they have successfully delivered what they promised to us.”

For this type of transaction, Standard Chartered was able to recycle the risk by tapping into its large network of clients.

“It’s preferred to hedge internally without trying to touch the market too much. So you sound out clients when you do a big trade to see who might have an opposite view, and look at where you can internalise some of the risk,” says Saurabh Tandon, global head of FX options trading at Standard Chartered.

Tandon says that the bank’s Asia franchise is quite diverse, and clients are always active.

“I imagine we are one of the first names on the Street when people think about doing something [similar] in Asia,” he says.

Innovative packaging

The bank is capable of offering bespoke solutions to clients by introducing the right product via innovative packaging. Such practices take advantage of dynamic market parameters and have played a key role in serving clients during the market rout this year.

“It’s an increasingly common objective across clients to reduce costs, and one thing specific to us is our ability to bring trades and package them into formats that clients are used to outside of financial markets,” says Lépinay.

For instance, embedding currency swaps and forwards in a non-derivatives contract – such as a loan – brings cost benefits and simplicity that clients are always seeking.

“Earlier this year, the demand for dollar liquidity has pushed cross-currency bases to extreme levels as USD liquidity commanded a high premium – but that also meant local currency has become comparatively very cheap,” Lépinay says. “So if you have access to that dollar liquidity – which we actually had because we’ve been very liquid through the crisis – and have the right conduit to deliver it, you could synthetically create very cheap local currency funding.”

Since a lot of clients are not keen to play in the cross-currency swap market, the bank offered to package such derivatives into loans, bonds or even invoice financing. For clients seeking funding ringgit, for example, the bank could offer local funding solutions 50 basis points cheaper than borrowing in the cash market.

“Clients don’t want to do a cross-currency swap for various reasons – due, for example, to CVA charges, incremental documentation or hedge accounting, so by doing things this way we can offer them the financing in the format that they prefer,” says Lépinay. “They just sign the usual financing contract and leave it up to us to package the derivative.”

Such innovative packaging has helped the bank to raise cheaper funding for its clients across Asia, Lépinay says.

New EM opportunities

Standard Chartered has been a pioneer in opening up new markets and serving clients in new currency pairs and instruments, following the wave of regulatory changes observed in FX markets across Asia closely.

The bank is in a unique position of being the only foreign bank in India currently eligible to participate in offshore INR non-deliverable markets. This enables Standard Chartered to transact offshore INR products onshore and offer liquidity to its franchise including Indian banks and international clients.

Since June 1 – when the regulator started allowing the trading of non-deliverable INR derivatives onshore – many Indian banks have been looking for liquidity providers for these products. Consequently, Standard Chartered India has become the leading market maker with a share of around 30% in the onshore market for INR non-deliverable products, offering liquidity to private sector banks, hedge funds, and non-resident corporate clients.

The bank has also been expanding its relationship with Chinese companies to deliver FX risk management solutions. Standard Chartered closed its first INR option with an onshore Chinese corporate. The firm needed to hedge its INR exposure worth more than $100 million. The product under discussion is a simple strip of USD call and INR put options. Education has been crucial in getting the client to shift away from selling options to ideally reduce cost to a more protective hedging strategy of buying currency options, which is more aligned in line with best risk management practices observed in US and European corporates.

For onshore China, the bank also introduced new FX structured products there. Mainland China still has a limited variety of RMB-denominated FX structured products because regulations restrict banks to use only vanilla FX options as a building block. Therefore, to introduce a new product, banks must think within the confines of what is permitted.

Standard Chartered China has launched a new product called the calendar FX forward. This is a simple product that takes advantage of the slightly inverted implied volatility curve in an onshore USD/RMB option by having clients sell short-dated options to boost the strike of the longer-dated forward. The structure has been well received and, shortly after its launching, Standard Chartered China traded with nine different corporate clients.

On the asset management side, with the continued growth of Asian markets, Standard Chartered has been able to leverage its unique position and footprint to provide investors with risk management solutions in frontier markets.

Standard Chartered began providing NDF prices in Pakistani Rupee to clients who would like to hedge their local currency investments or to participate synthetically. The bank is one of the few international banks that provides this platform, as well as having a significant onshore presence.

It also helped a global asset manager based in ASEAN to invest in Pakistani treasury bills while successfully hedging the potential FX risk arising from the investment at its desired level.

“Finding yields is again the big challenge for everybody, which is why we have added new NDF and options markets, and sometimes frontier currencies like Sri Lankan rupee, Bangladeshi taka, and Pakistani rupee,” says Lépinay.