In the second part of an interview with the head of the structured solutions division at Leonteq, Nilesh Jethwa, he explains how the cross-asset class and the click 'n’ trade set-up have become differentiating factors between those providers leading the market and those that will play a marginal role in the reverse inquiry space.
Has your trading background helped you to understand client needs better? And has a more cross-asset class approach, as opposed to a bias towards equities or another particular asset class?
When you are truly multi-asset, you get a much clearer picture observing the way in which capital flows from credit into equities or from risk assets to precious metals. Having a trading background has been crucial in helping me to approach the business with an understanding of risk. The typical sales mentality is to consider a trade as good as long as it adds incremental revenue, but from a trading perspective you have an extra layer to consider which is the risk involved in any transaction. As we've seen over the last few years, a very sales-focused management can be dangerous as risk awareness is not always top of the list. You also have to manage the fact that when the market is in risk off mode, we tend to do less business and therefore have less revenue. There is a need to bias the books to benefit in a risk off environment to cover the fixed costs of the business. Managing the relationship between risk and client flow is very much a trading competence.
How important is it to be cross-asset to succeed in the structured products market nowadays?
We are a cross-asset class house managing all assets on one platform, which is hugely important. Our clients are not focused on just one asset class, and if they think in terms of their diverse portfolio of equities, credit, commodities, funds and FX, you as a provider have to be cross-asset to be able to serve those clients. Ten years ago commodities were a marginal asset class in the structured products market but now it is considered mainstream. There will always be cycles as capital flows between asset classes but you need to be able to move and react quickly to demand. It is also very important to go hand in hand with your clients and educate them about the different possibilities structured products offer. Asset classes are interrelated and investors need to be aware of that interplay. For example, in a low volatility environment, benefiting from the relatively lower hybrid correlation is currently quite interesting. In my experience investors are in general a lot more sophisticated than a few years ago and react much quicker to macro developments.
What do you think is the biggest challenge for the structured products market?
We have seen that issuance levels have somehow recovered but the volume per product has gone down – there are now lots of smaller tickets. We know many traditional investment banks don’t like to do business for less than USD 1m per ticket, but we have just launched a public version of our ‘Constructor’ pricing tool in Switzerland. Subsequently we have lowered the minimum investment amount for certain structures to CHF 1k. We have understood and automated large sections of the value chain which reduces the cost of production and the risk of manual error. It’s not only about booking a trade and getting the revenue, which is the typical criticism of some investment banks, but about managing the whole life cycle of a product – the after sales experience.
We see a world where there will be thousands of clients independently creating bespoke structured products themselves in a fully automated and scalable fashion.
Since the crisis, the banking system has seen the time horizon for strategic thinking shortened. People are worried about losing their jobs and focusing on revenue rather than investing. We think differently. We now have a platform that makes it easier to do business, and we are hoping to attract new types of investors to our products.
Do you think the reverse inquiry approach will eventually phase out?
That is exactly the added value we offer. Investors can access optimised products across underlyings, payoffs, wrappers. Once the product is created they can trade it instantly, with all documentation being generated immediately and tailored specifically to the individual. They can also see statistics on platform activity and the best ideas currently going through the market. Putting the tools in the hands of our clients is a very significant development and it helps to increase the awareness and education of investors. The more control you give to people the more likely they will comeback to do business with you.
Do you think the market is fragmenting?
It will happen because those banks that cannot trade a large number of small tickets will compete on a small amount of big tickets to get the business moving. That is the only part of the market that is going to be left to those banks that have not invested in technology and automation. We could participate in that model as well, but we don’t think we can bring much to the table here that doesn’t already exist. However, what we do cannot be done by many at the moment and we want to capitalise on that. The structured products industry is going through a similar process to that which the travel industry went through a few years ago. Bricks and mortar travel agencies were the only place for people to book tickets to fly but that has now changed completely. Costs are now down and people can build a bespoke vacation on their tablets or smartphones based on the feedback of others and do so at a transparent cost and I’m sure there’s a correlation between these innovations and the fact that people now travel much more now and are more confident about booking travel in general.
What’s your take on multi-issuer platforms?
We are a multi-issuer platform and we are continuing to add more issuers as we expand our white-label offering. From a client perspective, choosing the issuer is an important part of the eventual product and if you can only sell one issuer risk then your product offering is extremely limited. It is also incredibly important to offer the same quality of service across all issuers. Our platform is issuer agnostic and the big advantage we have is that we manage the option or payoff risk in house for all issuers. This allows us to produce product reports, for example, where we break down the performance of a product according to the spot move, changes in volatility or correlation, dividends or interest rates, etc. We can provide all these reports across all of our white-label issuers. If you don’t manage the option yourself, you rely on the provider of the option to hopefully deliver this for you. If they haven’t managed to create the level of automation and scalability required then the client will ultimately be disappointed. In the end, without owning the option component, you are simply a broker whose platform is only as strong as the weakest product manufacturer on your platform. By vertically integrating the entire product manufacturing process we also cut out one layer of fees for the client.
Where is Leonteq going?
Structured products are our core business and we are completely focused and confident of succeeding in this market. The increased and specific regulation on structured products means that niche players will gain market share and the increased scrutiny by shareholders over the universal banking model will force many to question their USP in this space. Can the larger traditional investment banks really compete with the more nimble specialists who can react faster to changing regulation and increasing demands from a more discerning client base? We are working on adding more white-label partners over time to leverage our platform, we will integrate with core banking systems and we will develop our smart data concept. We will also continue to grow our unique asset management offering. We are at a stage of development where we can be opportunistic and flexible when responding to client’s investment needs and regulator demands.
Where is the market going?
Clients will expect the ability to tailor a structured product across a mix of asset classes themselves on a range of issuers. They will expect to be able to back-test their newly created product and download documentation dedicated to them. They will want to know what analysts are saying about the underlyings they have just chosen. They will want to have alternatives automatically suggested for them. They will trade more often, for smaller size, but expect platinum service levels. They will want to know what others in their situation are doing and will want to follow the best performers and opinion formers. They will want to perform analysis and understand the risk profile across their entire portfolio. They will want to be proactively alerted to profit taking or restructuring opportunities. They will also want to be backed by strong regulation that ensures best practice standards across the industry. We feel our firm is ready for this challenge.
Do you think that the funding side of things may weigh too much for banks to abandon the structured products market?
The treasury aspect is quite interesting. SPs emerged 20 years ago as an additional source of funding for banks. They became popular as an alternative to raising cash through classic bonds issuance as you could replace a fixed coupon with a variable payoff and attract more funding and at better levels. Today, we have gone full circle as some treasury teams stop paying for cash raised via certain structured products as they find it tough to live with funding which is a function of a stock performance, for example. What a specialist structured product treasury team can do is factor in that autocallable products provide longer-term funding in times of falling equity markets – which is typically when they need the cash. They will also know that an autocall product is likely to be reinvested in another product and hence the effective duration is much more than the model duration. This level of focus is tough to achieve when you manage cash flows across a large multi-faceted organisation.