Interest Rate Derivatives House of the Year: Deutsche Bank

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Upstream of the future new accounting standard International Financial Reporting Standard 17 (IFRS 17), the treatment of asset and liability term asymmetries is a growing concern of insurance companies around the world. But containing such balance sheet asymmetries with traditional interest rate swap hedges is far from straightforward, especially for local insurers operating in notoriously illiquid emerging Asian markets.

As a pioneer in bond derivatives solutions in Asian onshore markets, Deutsche Bank has transformed the way insurance clients in these markets cover such disparities.

“Much of our interest rate derivatives offering in the region is what we call bond derivatives,” says Ashok Das, Head of Trading and Local Market Solutions for Asia at Deutsche Bank. in Singapore.

“This includes all of the term extension swaps we have done that meet local and international clients and their needs regarding the asset and liability mismatches they have.”

Under IFRS On the 17th, insurers will be forced to use a market interest rate to calculate future general account liabilities, which were until now valued at cost. If that wasn’t difficult enough on its own, the drop in interest rates since the start of the Covid-19 pandemic also inflates the value of insurers’ liabilities which will need to be marked-to-market under the new standard.

A major problem for insurers is that the liabilities on their books are usually long-term fixed guarantee policies with high interest rates, which are difficult to match on the asset side, given the lack of liquidity in the business. long-term treasury obligations through many of the region’s secondary markets.

A setup like ours is crucial for carrying out these bond derivative transactions: the barrier to entry for [doing] this kind of products is very high

Ashok Das, Deutsche Bank

In addition, hedging these duration mismatches with interest rate swaps is also difficult for a South Korean or Indian insurer, due to low liquidity and lack of depth of content in local swap markets. .

Bond futures and bond futures (ENGs), which Deutsche Bank has negotiated with many clients in emerging Asian markets, offer a neat solution to the conundrum. The contracts are easy to understand and enjoy greater long-term liquidity that insurers seek to tap into.

The instruments have proven particularly popular with customers in India, many of whom have seen unprecedented inflows in their guaranteed return policies during the pandemic.

For example, the bank helped an Indian client to cover the duration of his ALM portfolio with a term bond on a synthetically created zero coupon bond that exactly matches the size and duration of the insurer’s liability, thereby achieving a matching risk-free term and eliminating the risk of reinvestment.

Another recent innovation is the use of total return swaps (TRS) as a means of reducing the cost of assuming liabilities in the Indian onshore market.

Traditionally, a TRS is an instrument used to provide access to offshore clients. Here, the instrument has been reused to offer onshore clients a way to offset fixed rate liabilities by receiving the yield on a sovereign bond and paying a floating rate plus a spread corresponding to their floating rate assets.

However, Deutsche Bank’s primary bond derivatives franchise extends well beyond the Indian interest rate derivatives market or the insurance client segment.

In addition to the asset-liability and duration hedges it has provided to insurers and other financial institutions in Asian markets, the bank is also using the instruments to provide leveraged access across the region to clients in the Asian market. both fast and real.

A host of other significant bond derivative transactions have been executed in the region’s markets over the past 12 months. The bank executed China’s first-ever long-term government bond futures contract to provide a customer with a ALM duration coverage, for example. In Taiwan, the first government bond option since the global financial crisis was negotiated. The bond derivatives franchise now even covers some frontier markets like Vietnam, where the bank recently executed the first total return swap on a Vietnamese dong bond in several years.

Ashok Das, Deutsche Bank

Deutsche Bank enjoys certain advantages over its competitors in the Asian bond derivatives market, which is a big part of how the bank maintains its leadership position in the market.

Das says the strength of the bank’s cash bond franchise is one of those perks. The bank’s ability to generate the underlying obligations for derivative solutions is enhanced by its onshore presence in 12 countries in the Asia-Pacific region, with lead trader licenses in many of these markets.

The other benefit, says Das, is having the infrastructure across the bank on a global scale to allow locally funded bonds to be integrated into global liquidity pools managed from central markets such as Singapore.

“A configuration like ours is crucial for carrying out these bond derivative transactions: the entry barrier to [doing] this type of product is very high, ”explains Das.

“Presence in local onshore markets, access to several liquidity pools and ability to manage risks on several aspects of these transactions [are] key to this business.

Finally, one of the main reasons the bank has been able to successfully expand its bond derivatives business is its ability to eliminate risk by circulating it to other customer segments globally. For example, the cross currency risks assumed on a term bond for a Korean insurance company can be offset by cross currency swaps where other clients take the other side of the risk.

Taking advantage of synergies between markets, products and customer segments is also a reason for the bank’s competitiveness in other areas of its bond franchise – such as the work the bank does as an arranger for issues. medium-term euro banknotes in Asian currencies such as Indonesian rupiah, Philippine peso and offshore renminbi.

In these operations, issuers seek to finance either we dollars or euros, giving rise to a request for currency swaps. Das says the bank is able to compete in this space in large part due to its ability to win these currency swap hedges among competing offerings from competitors.

“Bond derivatives have specific advantages over swaps, particularly in Asian onshore markets in terms of the ability to provide access to large pools of liquidity and longer maturities,” says Siddharth Chaturvedi, co- responsible for macro sales of the Asia institutional client group.

“The solutions provided by Deutsche Bank have benefited a diverse set of local and international investors and have met a wide range of client requirements: from term coverage to yield improvement to coverage balance sheet risk, access to the local market and leverage. “

Sustainability transparency

Another highlight of the past year is Deutsche Bank’s continued efforts to support the sustainability goals of customers in the region through its franchise of interest rate derivatives.

In 2020, the bank negotiated a first award-winning forward currency hedge linked to environmental, social and governance aspects (ESG), with a Singaporean multinational food and agri-food company. This year, the bank built on this success by executing a first green hedge backed by the opinion of a third party ESG consultant, rather than metrics reflecting the ESG Politics.

The exchange was for an Indian company that wanted to hedge a we green dollar bond, which it had issued in order to tap a larger foreign investor base. As the proceeds of the loan were intended to finance various green projects in India, the client company was exposed to USD/INR FX risk, hence the need for cross currency swap hedging.

But if it has been a market practice for some time for a ESG consultant to issue a second party opinion for green bonds, there is no such requirement for green bond hedges. Deutsche Bank, however, felt that a second-party opinion in this case would give bond investors greater confidence in the issuer’s risk mitigation strategies, ensure the long-term sustainability of green projects. and preserve the green bond repayment obligations. The client will include the green hedge transaction as part of their green bond allocation report.

So alongside the purchase of green bonds, which now constitute a large part of Deutsche Bank’s cash bond franchise, the bank is now able to provide green derivatives subject to exactly the same transparency requirements as bonds. that they are supposed to cover.

“What we have done here is provide cover alongside a green bond for an Indian client that offers transparency – not only on how they use the funding money, but also on how which they manage the risks of managing the cash flow of that asset going forward, ”said Andrew Pankhurst, director of Asia-Pacific risk management solutions at Deutsche Bank in Singapore.

“This is especially important for emerging markets because the macroeconomic environment is much more volatile and you want to make sure risks are managed prudently. “


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