Thomas Fang, head of Greater China risk management products intermediary sales at UBS

The Asian structured products market is slowly rebuilding itself after the fallout from the global financial crisis. High-net-worth investors are getting their risk appetite back but providers are having to structure shorter-term products in order to win business. Writer Michael Marray

Asian private banking clients have traditionally been much less risk-averse than their European counterparts and do not typically buy capital-protected structured products. As a result, many private banking clients had big structured product exposures to falling stock markets in late 2008 and early 2009. Losses were compounded by the fact that many high-net-worth individuals expected their banks to extend credit and so were hit by margin calls as markets plummeted.

One private bank estimates structured product sales are currently at about 20% of 2006 or 2007 levels. However, the market is once again gaining momentum.

"Reverse convertibles and particularly accumulator products were toxic in 2008, both for investors and the houses that provided them, and there has been a repricing of that risk. But we are now seeing investors moving back into structures that were familiar before the crisis, which is a bit of a surprise," says one banker.

The biggest surprise is the return of the accumulator products that were popular in the run-up to the crash. This illustrates the crucial point that, across Asia, structured products are closely associated with the financial crisis in a way that is not true in the European market.

In Europe, securitisation, subprime mortgages and even credit default swaps are most closely associated in the popular imagination with the financial crisis. However, it was structured products that became a symbol of the crash in Asia, with the accumulator becoming known as the 'I kill you later'.

Building bridges

Against this background, the rebuilding of the regional structured products market has understandably been slower than in Europe. But the basic risk appetite of Asian private banking clients has not changed, and though a few houses have tried to offer 90% or 95% capital-protected products, they have not gained much acceptance because of their lower returns.

In mid-2009, many private banking accounts had an appetite for low-rated corporate bond offerings, showing the chase for yield was on again. That encouraged structured product providers to put together trades with equity underlyings, building on the knowledge of existing structures across the region and engineering them to be slightly less risky.

Simple thinking

"Last year there was a flight to simplicity and more buying of fixed-income products as the market share of equity underlyings fell," says Renaud Meary, global head of structured products Asia-Pacific, global equities and commodities derivatives at BNP Paribas in Hong Kong.

"Equity underlyings are now back to more than 50% of the Asian structured products market but the trend towards simpler and shorter-term products is still to be seen," he says. "For example, the demand for reverse convertibles notes is overwhelmingly one-month maturity with single stock underlyings, while products such as daily range accruals are now typically three- to six-month products instead of two years before the crisis.

"Investors now better understand the risk profile of products such as accumulators after the losses seen in 2008 and early 2009 and have come back to the same kind of products as before, once their appetite for equity has returned.

"Providers are taking the lessons provided by the global financial crisis and making products that are close to what investors already know, but a bit safer than before. For example, we at BNP Paribas have developed a new version of accumulators that include a buffer zone below the strike price, within which the investor stops having to buy more shares. In a low volatility market this is clearly seen as an attractive feature."

An accumulator structure commits the investor to buying shares at a set price on a regular basis - thus accumulating shares every trading day - over a given period of time. The appeal is that the shares are bought at a fixed price that is discounted, perhaps at 15%, to the prevailing price at the time the contract begins.

The problem investors faced with these products during the crisis is that the downside is traditionally not capped, and during the crash investors found themselves having to make stock purchases far above prevailing market prices.

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Gerard Berclaz, head of markets, Asia-Pacific, at Bank Julius Baer in Singapore

A compelling story

Product providers are now bringing a new generation of products with enhancements that aim to limit the likelihood of losses for final investors. In February, for example, BNP Paribas launched a variation of the standard accumulator called an 'accumulator with buffer zone'. The new feature means that in a range up to 10% below the strike level, the investor is protected from having to make any stock purchases - significantly reducing the risk of incurring losses in a low-volatility environment.

In today's market, with stock valuations far below those of 2007, the downside is seen as less risky to family offices and individual investors, who generally have their own clear directional view of single stocks or indices and perhaps themed baskets such as the Asian consumer story.

Most underlyings were from Asia last year, reflecting the global trend that in a crisis environment, people tend to pull back to local stocks they know best. Today, US stock underlyings have come back to make up a good proportion of the market, and single US stock underlyings are quite common in markets such as Taiwan, Hong Kong and Singapore. European stocks generally remain under-represented in portfolios.

Presenting a storyline has always been important for structured products, though with such clear directional views from investors, this is less of a task in equity products such as single stock reverse convertibles.

However, last year there was interest in the commodities space, gold and oil underlyings, while in South Korea there were products based on natural gas prices. And in Taiwan, where the structured product market ground to a halt after the collapse of Lehman Brothers, new products on single stock underlyings were once again being launched from last November onwards.

"The overall trend has been to focus on more transparent and liquid structured products," says Thomas Fang, head of Greater China risk management products intermediary sales at UBS in Hong Kong. "Investors want pay-off formulas and fees that are easier to understand, and are either buying short-dated products or ones with good liquidity where they can move quickly in and out of a position."

"High-net-worth individuals want something they are familiar with and a strong storyline. On the back of that, Asian underlyings have continued to be popular with Asian investors, particularly since economic growth prospects are stronger in Asia compared to other parts of the world," he says.

UBS is also getting a good response on foreign exchange underlyings such as the UBS V10 algorithmic strategy, which uses carry trades between various G10 currency pairs as an underlying and adds volatility filters to make the strategy more compelling.

"There is also demand for baskets of currencies with a good storyline, such as baskets of emerging markets currencies that are expected to appreciate in value, or commodities-sensitive currencies," says Mr Fang.

"Investors are constantly looking for yield enhancement ideas, and equity-linked notes are one of the simple products which match that demand," says Gerard Berclaz, head of markets, Asia-Pacific, at Bank Julius Baer in Singapore.

"The choice of underlying is very much dependent upon location, and in the current market most Asian investors are more focused on local or regional Asian stocks, just as European investors are more comfortable with European stocks. We are seeing demand for structured products based on single stocks, as well as baskets and indices.

"Asian investors are now more cautious about issuer risk than they were before the Lehman Brothers crisis. The more conservative investors are still only willing to use issuers they are most comfortable with, even though the terms may be less attractive than those offered by counterparties with a lower rating."

Lehman impact

The failure of Lehman was a major event in Asian private banking since its notes were widely distributed via private banks, and led to a lot of litigation.

Regulation has been tightened up and in regions such as Taiwan and mainland China, it is now much more difficult for an investment bank to structure products and have them distributed via third parties into the mass retail market.

In Taiwan, products such as reverse convertibles and accumulators can currently only be sold to professional investors, which for an individual would mean having assets worth more than $1m.

The kind of volumes seen in 2007 look very high by today's standards but the market is certainly moving upwards again. In fact, a sign the structured products sector is recovering is that familiar complaint of bankers, who say they are experiencing a compression of margins because of competition from providers.

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