Credit derivatives house of the year: UBS

UBS may lack the funding levels of some rivals, but it can out-engineer them. The Swiss bank’s new customised funding notes (CFNs) deliver more attractive, tailored credit exposures – and have turned a funding constraint into a competitive advantage.

Traditional repacks tie a special purpose vehicle (SPV) issued note tightly to a specific bond, locking in that bond’s maturity and call features. UBS’s CFN creates an abstraction layer between the two. Rather than tying each note to a particular bond, the SPV holds a pool of eligible bonds from the chosen issuer, while multiple note classes can be issued against that pool. UBS can then manage the pool dynamically, using its portfolio of bonds to hedge the aggregate credit exposure created by the notes.

That makes the structure considerably more flexible. An investor can, for example, request a five-year structured note from UBS on a particular issuer even if there is no five-year bond outstanding for that issuer.

By pricing the note against a curve derived from secondary-market bond prices, rather than relying on a single bond, the Swiss bank can also establish a more efficient funding level for the desired maturity. This also helps reduce documentation and operational costs that have historically made small repacks uneconomical.

The innovation has been gaining momentum in Japan in the past year, where investors are already familiar with the SPV structures underpinning the products. UBS is now looking to replicate that success in other Asian markets.

“CFNs were developed partly in response to differences in issuer funding economics. They give us another way to deliver competitive, flexible credit solutions without relying solely on conventional long-dated funding,” says Christine Wang, UBS’s head of execution sales, Apac, global markets.

Clients already recognise UBS as a leader in innovation, with its ability to develop creative, tailored solutions helping it stand out in a competitive market.

“I think UBS’s credit derivatives solution is the best in the market,” says one client from a Taiwanese bank. “I’m happy to work with them because they really help me to solve my problems with the clients and always give me creative solutions.”

The product in question was a 10-year yen-denominated repack, using sterling assets as the underlying. A cross-currency swap was deployed to convert the exposure into yen. The repack was subsequently also extended to the Australian dollar and US dollar. The attractive coupon enabled the Taiwanese bank to offer more compelling investment opportunities to its wealth management clients.

“The UBS team listened to my request and tried to work out how they could provide me with a very good and very excellent solution,” says the client. “I want to say that everyone can give you some solutions, but UBS’s solutions are quite creative.”

CFNs were developed partly in response to differences in issuer funding economics. They give us another way to deliver competitive, flexible credit solutions without relying solely on conventional long-dated funding

Christine Wang, UBS

Big in Japan

Since acquiring Credit Suisse in 2023, UBS has demonstrated a strong commitment to Japan, including efforts to deepen its relationships with the country’s more than 200 regional banks.

Japan has also proved a receptive to the bank’s CFN innovation, partly because local investors are generally more familiar with the SPV structures underpinning these products than their counterparts in some other Asian markets. This familiarity helps lower the barrier to adoption, giving UBS a useful starting point as it looks to expand the approach elsewhere in the region.

“We have successfully promoted CFNs to institutional clients and we are now exploring solutions and applications that would be suitable for the distribution space,” says Wang.

Japanese banks have traditionally relied on their deposit bases to fund lending and build their credit portfolios. But as banks place greater emphasis on the returns generated by their capital, selling loans and credit assets can offer an alternative to holding them on their balance sheets. At the same time, life insurers are looking to invest cash in assets that meet their return requirements. This creates a distinct opportunity for UBS.

“We can bridge these flows by combining assets from banks with additional risk exposures, including CDSs, and packaging them into structured notes for life insurers and private wealth management clients,” says Jun Manabe, co-head of markets in Japan.

The CFN product is part of a wider push at UBS to connect Japanese banks with new credit opportunities.

While UBS focused on product distribution innovations last year, this year it has placed greater emphasis on expanding its credit solutions among institutional investors in Japan. These include banks and securities houses investing through their proprietary portfolios, which typically seek attractive carry, as well as insurers and pension funds looking for longer-term investment opportunities.

“The shift from deflation to inflation, together with rising interest rates, has accelerated a significant reallocation across credit products,” says Manabe. “Institutional investors are selling legacy low-coupon bonds and reallocating capital to new credit opportunities. As a result, Japan is gradually evolving from a bank-centred system into a more active and diversified credit market.”

He says UBS’s growth in Japan reflects its efforts to capitalise on this shift.

One of UBS’s strongest points is the ability to connect different parts of the credit ecosystem together. As investors rotate out of existing bond holdings, the bank can warehouse risk assets and transform them into tailored investment solutions.

Furthermore, through UBS’s international franchise and private client distribution channels, the lender can create new pathways for capital to move across the market.

“This capability requires deep technical expertise, innovative structuring and disciplined risk management,” says Manabe. “UBS is not simply benefiting from the transformation of Japan’s credit market; we are helping to shape it while supporting our clients.”

No silos

While Japan has emerged as an important market for UBS’s repack innovation, the bank’s ambitions extend across the wider Apac region, where differing investor needs and market dynamics create opportunities for further growth.

In Hong Kong, UBS has expanded its use of the multi-dealer Spire repackaging platform to develop tailored solutions for insurers. The structures can help clients manage credit and cross-currency exposures, using assets held within the repack to reduce the need for additional collateral to meet potential mark-to-market requirements on swaps.

“Many Asian insurance companies hold limited inventories of high-quality liquid assets, such as US Treasuries or Japanese government bonds,” says Wang.

When exchange rates or interest rates move, a cross-currency hedge can lose value for an insurer, prompting its counterparty to demand additional collateral. This can result in insurers scrambling to find sufficient cash or eligible securities to satisfy their counterparties.

“By using an SPV to overlay the cross-currency risk, insurers can draw on the collateral embedded in the underlying repack note to fund potential mark-to-market exposure,” Wang continues. “This reduces the need to post additional collateral over the life of the trade and provides a more efficient way to manage long-dated cross-currency risk.”

In Greater China, UBS has developed a repack strategy around convertible bonds, allowing it to serve investors with differing appetites for credit and equity risk. By separating the equity option from the bond’s fixed-income component, the bank can offer the option to investors such as hedge funds while repackaging the remaining credit exposure for investors seeking yield.

The strategy has generated meaningful activity this year, with UBS executing eight trades totalling around US$500 million.

Global connections

Underpinning all these initiatives is UBS’s ability to connect credit opportunities in Asia with investor demand across global markets.

With dedicated regional trading, structuring and risk management capabilities, the bank can originate or warehouse exposures locally, tailor them to different investor requirements and distribute the resulting risks through its international franchise.

This allows UBS to draw on demand from investors with different return objectives and risk appetites, while helping clients access credit exposures that may be difficult to source or structure through conventional channels.

“Our global business has locally empowered teams in Apac that can manage their own risk in the region,” says Peter Kennedy, global head of credit solutions at UBS. “We have the full value chain locally, enabling us to source a lot of risk in Apac and distribute it globally, and vice versa.”

This cross-border strategy is further complemented by the bank’s ‘One Bank’ approach that connects different divisions across the bank. This unified model is driving more cross-divisional referrals, helping boost UBS’s credit business in the region.

“Our ‘One Bank’ approach drives client origination, with subject matter experts working alongside relationship managers and bankers to develop solutions that draw on the strengths of the wider franchise,” says Wang. “Ultimately, when we grow revenue together as one bank, we succeed as a franchise.”