US structurer of the year

Credit Suisse

As the US market continued on the road to recovery last year, Credit Suisse sought solutions for yield hungry clients who were still sitting on cash. It found the answer in driving forward its callable yield notes business and using algorithms as the basis of exchange-traded notes (ETNs).

To help it do this, the bank boosted its structuring operations by assembling a structuring team that is one of the biggest in New York. "We knew that the game was going to get more complicated - in 2008 and 2009, most of my structuring team was in London with a couple of analysts in the US. We have hired six structurers in New York in the past year, and we have also hired several people on the analyst and research side," says Michael Clark, managing director, structured products at Credit Suisse in New York. The structuring hires included internal appointments from the bank's offices in Hong Kong and New York.

This meant it was able to quickly re-engineer and create products to meet client demand. One example of this was the callable yield note (CYN). "The portfolio conundrum people had was a matter of: ‘I have got all this cash but I am not making any money'," says Clark.

"We moved into the CYN business in 2008 and focused a lot of attention on it [last year] because we felt people were looking for an alternative on the yield side, and while they weren't expecting a 2008 event to happen, they weren't expecting great returns. Callable yield note structures met demand because they are generally protected 30% or 40% and they provide a coupon of high single digits to low double digits," he says.

The CYNs provided an alternative to the traditional reverse convertible - which has long been the most popular structure in the US market - and because they give broad index exposure rather than single stock exposure they are seen as less risky.

"We have opened structured products up to up distribution channels that usually wouldn't have looked at them if they were linked to single stocks," says Clark. Distributors include LPL Financial, Raymond James and Credit Suisse's private banking operations.

The popularity of this structure saw Credit Suisse's CYN volumes soar 143% last year, reaching a total of roughly $950 million.

"I think we lead with our strength here, which is equity-linked structures. People felt they had some exposure to the market and we managed to juice up the yield to give them an alternative to the 50 basis points they would get in the money market," explains Elaine Sam, director, equities, derivatives marketing at Credit Suisse in New York.

Not only did the bank ramp up its focus on these notes, it also issued new structures. One of these was the High-Low CYN.

"Implied volatility was decreasing , so yields were coming down. Some investors were fine with that, but others shied away because they were still fixated on getting high-single-digit to low-double-digit coupons. They were not that concerned about the downside risk, so we changed the structure of the coupon," says Clark.

The structure provides investors with a coupon of 12.5% as long as the underlying S&P 500 and Russell 2000 indexes do not hit a barrier set at 65% of their initial levels during the observation period. If that level is hit, the coupon falls to 5%. Credit Suisse sold about $100 million of this structure with various coupons and barrier levels.

Another tweak to the product was to add a longer duration before the potential for an early call. "Some [investors] wanted to lock in a high coupon for a year but it got called in the first quarter, so we re-engineered it to have a different structure for people who don't want it called so early. So we had a non-call six months and we had different variations of that," says Sam.

This structure also sold well, with sales of the non-call structure reaching around $100 million. The variations and flexibility that the bank provided were well received by its clients.

"We worked with Credit Suisse to identify a version of the structure that we prefer, and have been offering callable yield notes with exposure to broad-based underlying indexes that are well known to our clients. We elected to use a European-style knock-in feature because the single observation date makes it easier for clients to understand and measure. Credit Suisse continues to innovate, which is helpful because they come to us with new and timely ideas. The overall service has been very strong," says Thomas Layton, director of structured products at Raymond James in Florida.

More innovation from Credit Suisse has come in the form of the bank's decision to enter the increasingly important world of
exchange-traded notes (ETNs). The bank launched its first ETN in February 2010 and has so far issued 10 products, raising $325 million in assets under management.

When considering its entry to this particular market, Clark says the bank was aware that it needed a solid strategy. "The ETN market is the graveyard of so many investment banks. We are very good at offering a product for three weeks and then closing them but having a product out there for 20 years with no distribution fees is difficult.

"We surveyed the market at length and divided the ETN business into something we call trader tools - anything Vix fits into should be held for a day or a week, it's not something you can hold for 20 years, for instance. And then we have the algorithm business which is designed more for asset allocation."

Entering the ETN business was also a tactical decision for the bank as the financial markets face new regulations governing over-the-counter derivatives and banks are being encouraged to list products, say Clark.

Credit Suisse was the first to market with a hedge fund replication ETN (the Credit Suisse Long/Short Liquid Index ETN) but Clark's team had to make some changes to the original index to make it suitable for its clientele. "The index was originally presented to us by our partners in the liquid alternatives group as an ETF [exchange-traded fund]-based index. We changed that because if we are referencing ETFs in the US there are adverse tax consequences. The goal with most ETNs is to get long-term capital gains [but] constructed with ETFs you aren't going to achieve that," explains Clark.

The bank then added the US's first merger arbitrage ETN to its suite, which also offered tax benefits to investors. "If you hold a mutual fund, you get a phantom tax bill every year. We are manufacturing a better outcome using a structured product."

The index proved to have low volatility - even during the political turmoil in the Middle East and disasters in Japan - which made the product ideal for a leveraged version, which was launched in March and was the first US-listed product of its kind.

The ETN business has also provided the bank with a delta one hedging tool for its ETN desk and it has also been able to create options on the underlying strategies. "If you are considering doing options on merger arbitrage you have to buy and sell all these different deals," says Clark. "If you didn't have an ETN it would be impossible to offer optionality. The ETNs act as a core vehicle for us to rebalance our hedges on options based trades." The bank has completed options deals in the US and Canada based on its
Long/Short and Merger Arbitrage indexes.

Credit Suisse also launched risk-controlled versions of its indexes to make it possible to source cheap options in the low rates environment. These indexes gained interest from many client groups ranging from retail to institutional clients such as funds of funds.

Having established its toolkit, Credit Suisse was able to develop solutions for its clients. One such solution was developed for fund of funds manager Ranger Capital Group, which was changing its business structure to a managed accounts platform.

With the time lag between liquidating its current positions and being able to establish its new platform, the fund manager needed somewhere liquid to invest its clients' money. The answer to this problem was to provide a swap on a basket made up of the Long/Short and Merger Arbitrage indexes, as well as two ETFs. This meant Ranger Capital was able to obtain performance that closely tracks the Dow Jones Credit Suisse Hedge Fund Index, a benchmark for the hedge fund industry. The manager also used ETNs for some of its smaller funds.

This trade was for $50 million but in total Credit Suisse has issued around $300 million in swaps on its indexes.

To round off last year's offering in the ETN market, the bank also issued a suite of volatility products. Again, this was an innovation which responded to a need in the market. "In 2010, the big event from a volatility perspective was the flash crash. If you look at trading on VXX [one of Barclays Capital's Vix ETNs], it ballooned," says Clark. "That is one counterparty - there was a need for another one."

Another issue is the tracking error of the VXX, which has been widely publicised. "If you look at VXX, it references Vix futures. If you look at Vix futures versus the Vix, it doesn't track perfectly and there is beta of 50%."

Credit Suisse's solution to this problem was to bring out a leveraged Vix ETN with a beta of 80%. By adding leverage and increasing the exposure to the Vix futures, the tracking error was reduced. When volatility spiked earlier this year, the bank saw increased interest in its volatility ETN. "People took notice that the Vix would be up 20%, VXX would be up 8% or 9%, but TVix [Credit Suisse's ETN] was up 15% or 16%, so it was a much better tool for capturing that risk," says Clark.

The bank also came out with the first daily resetting inverse Vix ETN. The daily reset helps to counteract the negative roll yield that is inherent in futures-based products.

The volatility ETNs are distributed through New Canaan, Connecticut-based Velocity Shares, whose chief executive and founder Greg King is happy with the partnership.

"Credit Suisse has a platform that is solid across asset classes and they have showed an understanding of - and a willingness to do - complex products," says King. "They partnered with us for their institutional ETN effort and together we launched the first leveraged Vix ETN and the first daily rebalancing inverse Vix ETN. They have a strong capability in that asset class and have shown a very entrepreneurial spirit from a structuring perspective to work on new things which require significant derivatives risk management expertise. That overall package is pretty attractive to us."