Asian companies hedge their exposure

As corporations across Asia seek to hedge their bets, we talk to a Citi structurer about what's new in the marketplace.
Structured product volumes in Asia grew to around $300 billion in 2007, a 100% increase on 2006. But amid the global volatility, what structures are in vogue and what is the outlook for the market? CitiÆs Adam Gilmour, who is the bankÆs Asia-Pacific co-head of corporate sales and structuring, gives his thoughts on one of AsiaÆs biggest growth markets and what clients are doing amid these uncertain times.

What type of structured products are the most sought after in this current market environment?

We have witnessed some dramatic moves in financial markets this year, with many interest rates and currencies breaking out of long-term trading ranges not to mention the rise in commodity prices. In many cases these moves were historic landmarks such as oil hitting $100 a barrel.

Most structured products work on the assumption that underlyings will stay in the range. Hence demand from both the investor side and liability management has been for products that still perform to some extent on larger directional moves in the underlying reference index. In many cases this can be a simple addition of bought optionality, often with a strike far away to lower the cost. This works to cap a worst case or protect a minimum yield.

When markets are as volatile as we are seeing, customers get gun-shy of structures that are very complex. Most complex products sell volatility and as volatility increases in the market, they donÆt perform so well. So long as interest rates and foreign exchange rates are gyrating, investors will stick to more vanilla-type structures.

One trend we are seeing is an increased desire by corporations across Asia to hedge their exposure. Our corporate relationships across the region mean we have the ability to have a dialogue with thousands of corporate clients and bring in our product specialists from the fixed income, commodities and currencies and equities platforms to offer ideas and solutions as needed. With some of the increases in commodity prices, the price inputs for many businesses have in some cases doubled. This has led to increased hedging from corporate clients and in some cases the solution takes the form of a structured product.

Some recent examples of increased corporate hedging include providing solutions to airlines in India for their jet fuel costs and for a Taiwanese cement manufacturer, helping them hedge their coal cost û with the latter marking the first ever corporate coal hedge in Asia.

Is the continued economic downturn squashing demand for other types of structured products û say long-only or some of the FX carry strategies?

I do not think the economic slowdown so far is affecting demand for structured products so much as the large point-to-point moves we have seen in most markets. It is very usual and predictable behaviour of market users to step back from the markets after very large moves are seen. It is human nature to re-assess the new environment before making large decisions.

Most structurers I talk to are hoping for a decrease in volatility going forward in the next three-to-six months so that customers can regain some confidence in where markets are going or where the new trading range is likely to be.

In terms of where the underlying demand for structured products is, some of the core areas are international trade, financing flows and assets under management. In Taiwan last year, my equities colleagues handled a fund-linked structured product that raised $1.5 billion in assets for the fund in question and this trend continues.

In Asia trade seems to be as strong as ever, with most companies we talk to not seeing any meaningful slowdown in trade. Financing has indeed slowed down as credit markets have shrunk, but there are still deals being done and I feel liquidity is returning to the Asian credit markets.

This was underlined last week by a $500 million high-yield bond for Noble Group that marked the first Asian high-yield deal for over seven months. Capital markets activity is picking up, notably in local markets, and we will see a pick-up in flows related to primary market transactions with the markets slowly showing signs of life.

But some say the downturn in the market is good for structurers, because investors are thinking more about diversifying, and looking for new products.

I think a downturn in the market is not good for structurers, as mentioned before a large move causes participants to stay out of the markets in the short run. I do agree though that structured product users are looking for diversification away from particular asset classes such as structured credit, and in all asset classes users are looking for new products which have a more balanced risk and return.

Others say they are busy restructuring products. Are you in the same boat?

Yes. A structurersÆ ultimate expertise comes when a market moves a long way and the customers hedge or investment needs to be re-assessed. It is also important for customers to realise when a fundamental change has happened in a market, ie a new trading range will be seen, and react to alter their exposures to suit the new environment. I strongly believe a good risk management policy should encourage restructuring when large moves are seen.

Where are your new customers from?

For Citi, I would say the largest new user of structured products is in the commodities space. We have substantially increased our customer base in commodities this year primarily driven by the volatility and increasing risk that commodities play in companiesÆ exposures.

We are deeply embedded across Asia, with a fixed income, currencies and commodities presence in 17 countries and a sales force and trading team of close to 1,200 so we are already in the middle of the flows.

What is exciting, though, is that new business is coming from the combination of existing and new clients. We are seeing new client interest from countries as diverse as Bangladesh and Mongolia who want ideas on hedging and how they can use the structured product market for tailor-made solutions to meet their needs.

Existing clients are using more markets to hedge given the volatility across more sectors or are putting in place new structures in light of new movements in financial markets.

How do you see Asia's structured products market performing this year?

Volumes started strongly, but are currently slowing down, which is to be expected in May/June which are traditionally months when activity starts to slow down ahead of the summer. But I think the level of activity will pick up as the year progresses. IÆm very confident in the long run structured products will continue to be widely used in Asia both for hedging liabilities and for generating value on the asset side.
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