Bloomberg’s Abdessamad Khaled and Gaurav Kapoor discuss how structured products have performed and the role automation plays in maintaining stability.
Crises in emerging markets typically follow the same pattern: bad news in the market accompanied by volatility spikes, followed by a drying up of the primary market for structured products. A general nervousness also increases volume in the secondary market, as rattled investors look to unwind their positions.
However, this cycle hasn’t occurred in the structured products market during the pandemic, even during the initial spikes in Covid-related volatility in the first half of 2020. Primary market volumes have thus far remained reasonably strong as structured products continue to perform well. The extra liquidity provided by central banks has overcome the temptation to fly to safety.
In the past 18 months, yield-enhancing products such as autocallables, which account for the lion’s share of structured products issuance in the APAC region, continued their standout performance of recent years without any significant losses.
Despite the reduced liquidity in the credit market and significant rise in the risk of default for sectors such as oil and gas, the bid-offer spread for structured products remained reasonably tight. Markets recovered so quickly that few autocallable barriers were actually triggered.
Central bank action, technology, and especially a higher degree of automation played a major role in fostering this relative stability. The benefits of digitisation and especially the role of automation in maintaining stability and liquidity were felt sooner in the APAC region, where firms with a strong risk management framework fared even better amid the crisis.
Indeed, more sophisticated markets, such as Japan and Singapore, are looking to extend automation in structured products to cover post-sales and risk management processes. Meanwhile, emerging markets in ASEAN have also acquired a taste for structured products, the yield-enhancing features of which provide a good solution to low-interest rates.
Onshore China, for example, has massively increased its appetite for structured products in the last few years, especially among the local banks, which are striving to improve their risk management systems and automate workflows.
A key lesson learnt from the pandemic is that financial markets depend on access to quality market data and pricing models – and this dependence is especially obvious during volatility. In an ongoing crisis, inappropriate market data creates a whole host of issues.
All financial firms, especially banks, will continue to work on their digitisation strategies. This doesn’t mean they want to cut human contact completely. In this digitised model, clients will still have the opportunity to speak with their relationship managers, but the conversations will be more focused, backed up by data and automation.
Ongoing market changes like the LIBOR transition, low-interest rates, sudden spikes in volatility and sweeping regulatory changes will require firms to ensure they have the capacity to respond effectively, or lose out in the future. Other initiatives, such as the Uncleared Margin Rules (UMR), will require more technological sophistication, quality market data and robust models that can price structured products accurately.
In the APAC region, the continued growth of structured products is a response to specific demographic and socioeconomic challenges. For example, the increase in longevity has created problems for pension funds whose policies traditionally paid more if people lived longer. To cover the extra liabilities, pension funds need to grow their assets.
While interest rates and yields for more traditional asset classes remain low, structured products can help bridge the gap. Investors may also appreciate the high level of flexibility and customisation of structured products, often seen in regional trends.
In Japan, for example, there is a preference for repackaged products where the underlyings are Japanese Government Bonds (JGBs), Convertible Bonds, and Credit Linked Notes (CLNs). In ASEAN nations, the market is composed mostly of yield enhancement structures such as equity autocallables, albeit with extra demand from hedge funds for yield enhancement products across asset classes.
In China and Taiwan, there is a significant growth in demand for valuation and risk management of structured products, especially with regional banks. Some of the most common structures include digital barrier options, Daily FX range accruals, Shark Fins, Wedding Cakes and Basket Bull/Bear Spreads with quanto features, among others.
There is also interest in structured products with ESG themes and underlyings/indices across all jurisdictions.
Meanwhile, there are ongoing initiatives by local regulators to improve risk management and valuation services for structured products, opening opportunities for regional expansion by local and global sell-side firms in wealth management and private banking.
Major sell-side firms in APAC are also looking to expand into other jurisdictions within the region. As firms with a footprint in different jurisdictions look to comply seamlessly with local regulation, the need to invest in technology that improves lifecycle management and distribution capabilities will be made more apparent.
In today’s fast-changing landscape, building the right technological foundations to improve resilience and cost-efficiency will prove to be crucial.
The article was written by Abdessamad Khaled, Bloomberg’s Head of Structured Products, and Gaurav Kapoor, Bloomberg’s APAC Head for Sell-Side Risk and Valuations.