A shift from offering clients hedging to a more solutions-based approach and careful risk management strategies has driven Bank of America’s success in a field dominated by European banks. Edward Russell-Walling reports.

Team of the month 1109

From left: Raafet Azzouz, Tim Whiteley, Sheldon Chychrun, Trevor Randolph, Yuriko Mita, Hichem Souli, Paul Baron, Will Holligan

In The Banker’s Investment Banking Awards for 2019, the honours for the most innovative performance in equity derivatives went to Bank of America (BofA). The citation noted that, while this category was often dominated by French banks, it was impossible to ignore BofA’s “meteoric” expansion in this business.

There is, however, still a French connection here. BofA’s head of global equity derivatives sales and structuring is Hichem Souli, who has led the bank’s new approach to equity derivatives. Until 2014, when he joined the US bank, he was European head of cross-asset pricing and solutions at France’s Société Générale.

Historically, European banks have been more solutions driven in equity derivatives. For US banks, activity used to be much less bespoke and more technical, driven by hedge funds rather than asset owners such as pension funds and insurance companies. “In the past four or five years, however, US banks have entered the solutions business as their clients have started to request it,” says Mr Souli.

Move to passive

The continental gulf between the European and US approaches has been narrowing, as market needs have changed and US banks have adapted their offering accordingly. This has been driven by various factors. Since the 2008 crisis, financial institutions generally have been regulated more tightly. 

Asset owners used to give money to hedge funds, who promised high performance. But for the past five years, hedge funds have in fact underperformed, prompting a shift from active to passive management which, with its considerably lower fees, is more cost-efficient. “In the middle of that shift, institutions still needed to generate alpha to meet their liabilities,” says Mr Souli. “In a scarce yield environment, they still have to perform – hence the need for solutions.” 

That shift has been gathering pace in the US, where large pension managers, such as the State of Wisconsin Investment Board and the Teacher Retirement System of Texas, have publicly taken money away from hedge funds and started to manage it themselves.

Insurers have been going through much the same process, as the onset of lower interest rates has obliged them to consider how to keep their annuity products attractive to buyers. “Before the crisis, insurance companies’ approach to derivatives was generally to come to banks for balance sheet,” says Will Holligan, Americas head of insurance and corporate equity derivatives sales at BofA. “Most of the business we saw was flow hedging.” 

Since the crisis, and particularly in the past five years, they have seen equity derivatives in a new light, according to Mr Holligan. “It is a new world. They come to us with what they want to achieve and ask for a solution-based approach,” he says.

European DNA

BofA has not been the only US bank to respond to a changing marketplace, but it has been particularly proactive and innovative along the way. As Mr Souli says, equity derivatives in US banks used to be mostly flow-centred, while in European banks the focus was on bespoke solutions. One of his missions has been to transplant that European DNA into BofA.

He was charged with building the solutions side of the business and boosting the exotic products offering. Using the bank’s key strengths in research, in flow derivatives and in trading, he rebuilt the structuring team so that it moved from the wings to centre stage. “We put structuring in the middle of the trade, so that it became a bridge between trading and the sales force,” says Mr Souli. 

The key to making the solutions business work is the originate-to-distribute model, he adds. Banks today are more constrained in the amount of risk they can warehouse, and need to find new ways to repackage and transfer risk. “In order to continue to service client needs, banks must build efficient conduits to recycle risks across market participants,” is how Mr Souli puts it.

So as soon as BofA has structured a solution for an asset owner client, it will move the risk, via risk-transfer products, to its hedge fund and relative value clients. That frees up the bank’s balance sheet to sell more retail products. “BofA is the biggest issuer of structured products in the US,” says Mr Souli. That creates a large inventory, which the bank can work on and repackage.

Innovative structures

BofA’s solutions involve technical and structuring innovations that will sound arcane to the lay person but have nonetheless impressed its clients. The bank says it has targeted several topical issues, such as risk management of exotic options, forward skew, volatility risk premium programmes and the impact of the Federal Reserve's U-turn on equity rate correlation.

In one specific innovation, its Fast Convergence technology, removes the volatility risk premium, or implied-to-realised volatility spread, by making volatility a known and quasi-constant parameter. So buyers get cheaper options and sellers avoid the ill effects of volatility [inefficiency]. BofA has also focused on the challenges faced by risk premia strategies and the optimisation of intraday delta hedging. One other area of innovation in which it has been a market leader – and which it believes has ample room to grow – is investable indices.

“Investable indices have experienced the fastest pace of growth among the different solutions businesses in recent years,” says Mr Souli. BofA has created a large stable of index products reflecting different assets and strategies, and today manages unspecified “tens of billions” of dollars across asset classes. This side of the business has benefited directly from the shift away from active management into passive.

“Pension funds, sovereigns and asset managers have moved from allocating to managers to allocating to systematic strategies," says Raafet Azzouz, Americas head of pension, endowment and asset management solutions sales at BofA. Some $2000bn has moved from active to passive management over the past 10 years, he adds.

In consequence, large asset owners have turned to a greater level of in-house asset management, and have invested a lot in technology and in-house talent, according to Mr Azzouz. “The systematic strategies we create lie between hedge funds and ETFs [exchange-traded funds] and share some of the characteristics of both,” he says. Now we are at the end of a 10-year bull market, asset owners want not only to generate alpha, but also to protect their returns, he adds. “This is where we have had tremendous success, and that concern is not disappearing.”

The bank uses a mix of state-of-the-art financial engineering and innovation together with senior relationships to leverage its equity derivatives platform, he says.

Long-term relationships

These relationships do not come together in a hurry, according to Trevor Randolph, BofA's head of global equity finance and solutions. “Financing relationships are long term by definition. The relationship then leads to a natural discussion of ideas about other products on the equity side, or even private banking.” 

He points to the structural change that he has seen in the financing business, with a larger spectrum of clients requesting a wider range of solutions. “We went from a world where we were providing liquidity to a unique category of clients to a world where we are facing multiple clients with different financing needs,” says Mr Randolph.

The team has been growing steadily, with headcount growing recently by as much as 25% a year. Mr Souli is particularly enthusiastic about the prospects for systematic strategies. “There has been a lot of talk about active versus passive strategies, but no one talks about the piece in the middle – investable indices,” he says. “That can only get bigger, as the creation of systematic strategies is increasingly driven by technology.”

Mr Souli believes the US market is the holy grail for systematic strategies, saying: “This is just the beginning. And the beginning is the most demanding part.”


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