Structured products investment is becoming more mobile, with investors looking to new regions for higher returns. European and Japanese markets have proved enticing over the last year or so, while China is moving ever closer to releasing its full potential as an investor destination.  

Over the years, structured products investors have acquired a reputation as homebodies, rarely straying far beyond their own country or region in search of returns. There are good reasons for this caution – the structured products market is complex and the instruments themselves are often composed of many layers, with returns contingent on the alignment of various factors. Better to stick with what you know and limit exposure to unfamiliar territory, then. 

This attitude does seem to be changing somewhat, however. The low-interest-rate policies pursued by many developed economies have choked off yields, forcing a number of investors to cast their net over a wider range of asset classes and geographies. 

“What is clear is that in the past 12 to 18 months we have seen a lot more cross-regional flows – US investors pushing money into Europe, Europe investors looking at Asia, and Asian investors moving toward these two regions in return,” says Eric Personne, global head of multi-asset structuring at Citi in London. “There is far more investor mobility in this market than ever before.”

Global hotspots

Strong equity growth in Europe has made the continent particularly attractive for American investors. “US equity funds are allocating more and more resources to Europe, driven by the European Central Bank’s quantitative easing policies and the hope that this will lead to a sturdier period of economic growth, and the fact that European equities remain relatively well priced compared with their US equivalents. There is a lot of potential for further returns in this area,” says Peter McGahan, head of global market sales for the Americas at Société Générale.

“These inflows are fairly evenly spread across central and peripheral eurozone countries, indicating that investors are not put off by the Greek situation.” 

Japan has been on the radar of overseas structured products users since the advent of ‘Abenomics’, an economic strategy devised by prime minister Shinzo Abe in early 2013 to end the country’s long period of deflation and stagnation. Japanese equity markets responded almost immediately, with the Nikkei 225 rising from 10,688 points on January 4, 2013, to 20,460 points on June 5 this year. In Europe, equity markets remain fairly unperturbed by the rolling Greek debt crisis, producing solid gains for the Stoxx Europe 600 and the FTSE 100 so far this year. 

As a result, dealers say they are executing a significant volume of structured products designed with underlying exposure to European and Japanese equity with clients across the globe. To take Japan as an example, long-term equity structured products with autocalls linked to the Nikkei 225 or a basket of selected Japanese equities have become increasingly popular worldwide.

Anxieties eased 

The lure of these instruments is now strong enough to overcome investor anxiety over increased foreign exchange (FX) exposure. “Stock market growth in Europe and Japan has been accompanied by a significant depreciation in the euro and the yen,” says Rui Fernandes, international head of structuring at JPMorgan in London. “Investors are aware of that, so they are putting money in cross-border products that also contain a currency-hedge element. Today there are a lot of very efficient and relatively cheap ways to do this, so even clients without much experience of FX exposure can feel comfortable in taking on these products.” 

Given the relatively opaque nature of the structured products market, the rate of inflow into currency-hedged products is hard to measure. However, dealers say figures from the more public exchange-traded fund (ETF) market offer a rough correlation – by mid-March this year, Wisdom Tree, one of the largest ETF providers in the US, had nearly $17bn in its European FX-hedged equity ETF, and $16bn in its Japanese equivalent. 

More and more investors are also looking to FX to form a return component in their structured products. Regulatory changes have made fixed income a more expensive asset class for market makers, particularly the over-the-counter derivatives trades that are part of many structured assets, and bond market liquidity is not what it once was. The low-rates environment has also depressed fixed-income volatility, making it an unattractive asset class to many investors.

The FX market is emerging from a prolonged period of historically low volatility, and it is possible to construct products that use an FX component to replicate returns found in fixed income. The structured products businesses at some banks have become increasingly cross-asset in nature, allowing them to offer hybrid instruments that offer equity-linked returns overlayed by an FX carry strategy. 

Another option is to resurrect FX-infused instruments that proved successful under similar market conditions in the past. “When yields were exceptionally low in Japan during the 1990s, many capital-protected notes appeared on the market that allowed Japanese investors to denominate the principle in a non-yen currency that offered a better return,” says Delphine Robertson, senior structurer at JPMorgan in London. “We might see a return for this type of product among investors in Europe if fixed-income returns do not improve there soon.” 

Attention on Asia

When looking towards Asia, the gaze of outside investors may initially fall on Japan, which comprises 40% of the region’s structured products market. However, the strong economic growth experienced by a number of neighbouring countries has made them an attractive prospect too. 

China occupies pole position in this regard, bristling with investment opportunities even as gross domestic product growth slows slightly. The Chinese government is in the middle of a series of careful policy reforms that will further liberalise its economy and improve access for offshore investors.

Early last year, the People’s Bank of China intervened in the renminbi exchange rate and weakened it against the dollar to promote two-way liquidity in the market. In the following months it widened the daily permitted trading band on the currency from 1% to 2%, and then to 3% in July. That month, rules surrounding the setting of renminbi/US dollar exchange rates by domestic banks were also loosened. The process by which foreign corporates expatriate renminbi earnings has been made easier, too, via changes to current accounts held in the Shanghai Free Trade Zone.   

In equities, the connection between the Shanghai and Hong Kong stock exchanges, allowing investors in each market to buy shares in the other via their local banks and clearing houses, has been up and running since November 2014, and in mid-April notched a record $37.9bn in daily volume.

Bumps in the road 

There have of course been hiccups. On June 9, global stock index compiler MSCI announced it would not be including mainland China-listed shares in any of its indices, most notably its Emerging Market Index, until issues over market accessibility had been resolved with Chinese regulators. These included concerns around quotas for large investors and capital mobility. It had been thought that MSCI would give a minimum 5% weight to Chinese stocks in a select number of its benchmarks, though the firm said that the stocks would remain on its review list for inclusion in 2016. 

At around the same time, Vanguard, another benchmark provider, forged ahead with Chinese stock inclusion, allocating a 5.6% weighting for Shanghai-listed companies in its emerging markets ETF, which has roughly $50bn in assets under management. 

“Once you open this door, it will only ever open further. China is liberalising market access at a faster and faster rate,” says Yann Garnier, head of global market sales for Asia Pacific at Société Générale. “Chinese authorities are accelerating the pace of opening up their market and there is not a single month where we don’t hear about a new set of reforms.” 

“It starts with stock connect – for greater access to benchmarks, and listed stocks, then it should continue with listed options on index first, then listed stocks then the opening of repo and lending markets. India is also looking closely at the Chinese example, so there is more money coming into the Asia region than ever before. Asset managers have traditionally allocated 5% to 15% of their portfolio to Asia. Driven by accommodating central bank policies, structural reforms and market momentum, in many cases that has increased to 20% to 25% into Asia, or higher still for some macro funds.”

Buyer beware 

There is still an element of ‘buyer beware’ for structured products investors operating in these markets, however. Accurate valuation is often a problem, especially for instruments that have a limited historical presence or for which liquidity is patchy. Accurate research on economic intricacies and the likely direction of underlying instruments is often scant, and some local regulators lack sophistication. The fragmented nature of Asian markets, with major trading hubs scattered across the region in Hong Kong, Singapore, Tokyo, Shanghai, Seoul and Taipei, means that banks often have to have a local presence in many different places to offer full coverage. 

“Following the financial crisis, Asian local regulators have strengthened the supervision of financial activities, putting greater emphasis on local licences asking foreign banks to put capital onshore in return for access to their market. This has forced international banks to make a choice on which local markets in Asia are strategic to their activities and put capital and human resources onshore to develop these markets,” says Mr Garnier. 

Establishing more transparency in the market is also vital. Société Générale, Barclays, BNP Paribas, Goldman Sachs, HSBC and JPMorgan recently embarked on just such an endeavour, entering into a partnership with Hong Kong-based technology firm Contineo to establish a service that will compare bank pricing, starting with equity-linked notes and expanding to more instruments over time. It is hoped that the service will improve product standardisation and lead to high volumes and greater competition between banks.


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