In an increasingly unpredictable economic environment, investors are looking for a wider range of products to satisfy evolving strategies. Pauline McCallion reports
Following a long period of historically low interest rates – in the wake of the financial crisis that began in 2007–08 and the more recent Covid-19 pandemic – central banks worldwide are beginning to raise rates again. While this has led many investors to shift parts of their portfolios into longer-term solutions, it has also highlighted a split in investor expectations for the global economy.
Gaurav Pugalia, UBS
“There is a lot of fear and uncertainty in the investor community now because the jury is still out on the future for the global economy,” explains Gaurav Pugalia, head of macro structuring, Asia-Pacific (Apac), at UBS. “There is no consensus view in this market – there hasn’t been for a while. And now there are really two types of investors.”
One set comprises those that remain fearful of interest rates going back up and inflation picking up. These investors want to keep durations manageably short, given concerns that long-term bonds could be affected by rates going back up to combat rising inflation.
“But there’s an equally forceful set of investors who think the worst is behind us,” Pugalia continues. “They see the world as a lot more certain and predictable, with inflation calming down and rates [set to] slowly but surely keep coming down and stay down.” This latter set of investors now wants to add duration to their portfolios, especially after hesitating to do so during the most recent rate hike cycle.
In the current increasingly unpredictable market environment, banks are developing solutions to satisfy both sets of investors.
A new economic environment
In 2012, UBS was one of several major financial players to exit key parts of the fixed income space in response to new capital regulations put in place following the global financial crisis. As the industry got to grips with these regulations in the ensuing years, many of these banks have started to return.
UBS took initial steps in this direction in 2020, creating a single global markets team from its foreign exchange, rates and credit units. More recently, this strategy has been bolstered by UBS’s integration of Credit Suisse following its March 2023 acquisition of the bank.
By adding Credit Suisse’s credit solutions expertise and experience, UBS has been able to re-enter several key parts of the market more quickly than expected. UBS is now significantly expanding its product capabilities to better serve evolving client needs in the current global economic environment. In the Apac region, this has involved a particular focus on the longer-dated and more structured fixed income space.
The newly expanded UBS is now able to offer “more things to more clients” across its growing Apac business, says Pugalia. “Before the integration, we were very focused on the short term, which worked because many investors also wanted to be short term. Now, with a larger set of investors moving to the longer end of the curve, we can keep up with them too by providing competitive, attractive products.”
UBS’s attitude to risk – which, Pugalia points out, has not changed following the Credit Suisse integration – is key here. Post-integration, UBS has capitalised by offering new products such as self-issued, long-dated zero-callable total loss-absorbing capacity (TLAC) bonds.
“Traditionally, unsecured TLAC instruments for most banks tend to be very simple bonds, because that is how regulators want them to be,” Pugalia says. “But, if an investor has a need for something a little bit more structured, we can provide a combined solution, giving the client access to our TLAC funding because they like the UBS name and want to invest in the long-term bank credit of UBS, but also have some access to a different kind of payoff.”
Vallabh Shastri, UBS
Similarly, UBS Lux is a special-purpose vehicle that allows investors to access UBS Group AG funding while also delivering structured payoffs. “As one of our flagship offerings, we can use UBS Lux to manufacture longer-dated products. These are attractive to clients because, when we create an asset, the cash the investor puts into the asset has to sit somewhere. We use this vehicle to give them attractive rates for longer-dated products,” explains Vallabh Shastri, head of structured credit and financing structuring, Apac ex-Japan, at UBS.
Actively managed certificates are another form of structured product UBS has been using to allow clients to implement derivatives-based investment strategies without the need for their own trading capabilities. “UBS was already very strong in delivering actively managed certificates for external asset managers who wanted to implement a strategy without [the expense of] launching a fund, for example,” Shastri explains. “As a result of the integration, we have brought across a lot more of these efficient off-balance-sheet vehicles.”
A stronger offering
All of these products play into the paradigm shift banks are seeing as investors address the changing economic environment and look for longer-dated products. And, on the other side of the balance sheet, investors are also looking to raise cash against certain assets or investments they have already made.
“Products such as synthetic total return swaps can work particularly well for government bond holdings, for example, especially domestic government bonds that investors might hold in a number of different jurisdictions in Asia, such as China, the Philippines or Indonesia,” says Matteo Cappellini, head of structured financing, Apac, global markets, at UBS.
A bank can reduce the cost of financing by having the client embed an option sale to the bank. These longer-tenor products often attract clients with portfolios of five- or 10-year government bonds they want to hold to maturity while accessing additional financial benefits in the meantime.
Under current capital regulations, banks can often deliver a pricing advantage versus private equity funds when it comes to using such securitisation structures to finance loan portfolios and private credit assets. Transactions can be arranged in a structured way that allows the bank to provide term funding to non-bank lenders and credit funds against their portfolios of assets, Cappellini says.
UBS has migrated such transactions from Credit Suisse after the acquisition and has also been building this part of the business further. Non-bank lenders can use them to lock in financing for several years on a portfolio of assets that is also potentially dynamic. As Cappellini explains: “These transactions are effectively structured in a way that gives us an advantage from a resource perspective, while allowing us to be able to give term funding to the client and provide them with the ability to switch assets in and out during the life of the transaction.”
The client can access term funding but also benefits from flexibility on the underlying collateral within parameters set by UBS at the outset of the transaction. “By establishing parameters upfront that we are comfortable with, we can manage the risk and the funding accordingly during the life of the trade,” he adds.
In addition to its standard offering, UBS has been tailoring all of these products to suit the burgeoning Islamic finance market in Apac. “We can offer broadly the same conventional products but deliver them using contracts that are sharia-compliant,” Shastri says.
While UBS was not in this market before the integration, Credit Suisse was, and the Apac team felt Islamic finance was a good fit for the combined business strategy post-merger. Having migrated trades from Credit Suisse and brought over talent, UBS is now able to offer Islamic contracts to this growing market in Southeast Asia.
A greater focus on Japan
The integration of Credit Suisse has also transformed UBS’s presence in Japan. It has gone from having a “minuscule” presence to making Japan a major focus with a comprehensive and adaptable fixed income strategy, says Shastri. In addition to three recent regional sales hires, the bank has added four traders focused on structured hybrid products. This team manages both of those positions migrated from Credit Suisse’s books and UBS’s expanded offering of structured credit products in Japan.
“The fixed income market is a very hot topic because the Bank of Japan raised its short-term policy rate for the first time in 17 years in March 2024,” says Tsuyoshi Matsue, head of fixed income structuring, Japan, at UBS. “We are expanding the fixed income business in Japan in response to changing investor needs, and the Credit Suisse integration has fitted well with these expansion plans.”
As such, hybrid products are a key growth area for UBS in Japan. The team is also collaborating with others across the bank to offer new investment products tailored to the changing needs of the country’s investors.
UBS is also offering more flexible product structures, such as constant maturity swap- and QIS-linked coupons. According to Matsue, by offering these more diverse and tailored financial products, UBS has already begun to broaden its client base in Japan.
A new way forward
While UBS has taken on many key business lines following the integration of Credit Suisse, it is also unwinding those that don’t conform to the bank’s post-integration strategy. Overall, however, Shastri believes the integration has helped UBS “leapfrog by years” its re-entry into certain parts of the fixed income space that it had exited after the global financial crisis.
“Bringing the strengths of the two firms together has accomplished in a matter of a year and a half what would have taken UBS several years to accomplish on its own,” he says. With the integration of Credit Suisse’s fixed income business now “more or less complete”, Shastri says the focus is on growing the franchise through a broader range of products and market coverage.
“We have a very clear vision of what the fixed income business should look like in the current market environment, especially in the Apac region,” he says. “There has been no increase of risk appetite, but now we’ve brought over key talent and transactions [from Credit Suisse] and it’s a very exciting time for the bank – especially in fixed income.”
Following the recent interest rate hike cycle – and even more so now, amid ongoing geopolitical uncertainty – investors are looking for a more nuanced range of solutions. In this environment, banks that offer “more things to more clients” can help clients to strike the right balance in rapidly changing market conditions.
