Standard-setter searches for the perfect product

Once you have managed to breach the James Bond-style high security of the glass SocGen twin towers in Paris’s financial district, you expect an M-like character to be running the place, sitting high above the futuristic French landscape.

The bespectacled, softly-spoken yet steely-eyed Bernard Desforges does not disappoint. As global head of equity derivatives, responsible for more than 450 sales and financial engineering staff in Société Générale’s corporate and investment banking division, plus its Lyxor Asset Management subsidiary, he appears the consummate plotter for world domination in structured products, minus the white cat.

This business is so lucrative that it has become a key battle-ground among French financial institutions. The Boston Consulting Group believes equity derivatives is one of the fastest growth areas in investment banking, expecting it to deliver revenues exceeding $20bn (e16.6bn) by 2007, with margins as high as 45 per cent. Merrill Lynch estimates that SocGen will earn $2.6bn from equity derivatives during 2005 with a pre-tax margin of 44 per cent. Both revenue and marrgins are well up on the previous year.

French rivals are keen to copy the money-making machine at SocGen, which has become the clear market leader since its equity derivatives division was established in 1989. A handful of key SG staff have crossed over to Calyon, a rival French investment bank created from the merger of Credit Agricole and Credit Lyonnais, currently creating much noise in the market.

In fact, there was also a prolonged tussle for the signature of Mr Desforges’ deputy, Eric Le Brusq, between Calyon and BNP Paribas, with the former a clear favourite to sign him. But at the last minute, the fleet-footed Mr Le Brusq popped up unexpectedly at the latter. Typically, the matter is handled crisply, without any bitterness by Mr Desforges.

Although one fears the floor of the cylindrical security booths, through which staff must step to enter the trading floor, may open up into a shark-infested tank at the push of a button, the defectors have definitely reported for work at the rival institutions. “Calyon is a small investment bank. The size of their equity derivatives business is small compared to Société Générale, and their goal in terms of revenues is only one third of SG’s existing revenues in equity derivatives,” says Mr Desforges, playing down the defections.

“As a French bank, they have to hire French speakers. But the number of staff they have lured from SG is limited. We have 850 front office people, and they have taken five or six staff, so we are talking about a very limited impact.”

While French retail and high-net-worth investors have demonstrated a clear appetite for structured equity products pushed by staff through banking networks, Mr Desforges expects growth from right across Europe.

“The equity derivatives business is totally cross-border,” he says. “France only accounts for a small portion, and there is no way we can limit ourselves to French boundaries.”

Working with rival networks

The UK is one particular market Mr Desforges has targeted for sales growth. “London has lots of financial institutions we need to service. There are pension funds, asset managers and hedge funds, in addition to distributors such as banks and insurance companies. UK banks such as Barclays need to send their guys to Continental Europe, while the French banks need to have significant numbers of staff in London.”

SG has also had much success in penetrating Continental European markets in Spain, Germany and the Benelux countries. It has worked hand-in-hand with distributors in Spain such as BBVA and Santander Central Hispano. KBC, Fortis and Delta Lloyd are all admired by Mr Desforges as innovative, volume distributors in Benelux, while Deka Bank and the Landesbanken are key outlets in Germany.

As well as his own SocGen network in France, Mr Desforges’ team has been known to work with the networks of rivals BNP Paribas, La Poste and Natexis Banque Populaire.

Which banks he chooses to work with is very much a function of the volume of products they can offload to a captive retail client base.

“Santander and BBVA are really impressive,” enthuses Mr Desforges. “But what you need to look at is the sales people in their branches, and what they do on a day-to-day basis. These big distribution networks in Spain have spent huge sums training their staff. The momentum has been created, and there is no way they can change their behaviour dramatically,” he adds, in the belief that the Spanish investor’s love of equity baskets, with an underlying guarantee, is not a fad, but something that will be fuelled by the major networks for many years.

“Training a big force like BBVA, La Caixa or Caja Madrid is a huge commitment, and not something you can achieve in a matter of weeks, so we are very confident there will remain a huge market for structured products in Europe.”

The technical brains employed by Mr Desforges, with the mathematical knowledge to structure equity derivatives, are constantly dreaming up new structures for distributors.

“We try to develop very good product creation expertise and pricing of funds, using a large group of people fully dedicated to this area,” says Mr Desforges. “A product can often start as a funny little idea, but little by little, it turns into something good-looking. It’s very difficult to get a client to transfer their investment portfolio from one bank to another. But a good product can help the client transfer a significant part of their assets.”

As well as creating a semi-permanent product structure understood by all bank branch staff, which can then be tweaked to adjust asset allocations between underlying instruments, Mr Desforges believes the new breed of structured products (see box) offer a viable alternative to actively managed mutual funds.

“If you look at European equity funds, they are a pretty straightforward way of managing assets. But having a tool kit of derivatives can help distributors to create new structured products which innovate. ”

Big distributors in Europe use these concepts as a hook to develop the loyalty of new clients, and because market conditions are constantly changing, the opportunity is always there to renew the structured product range. Regulations and the long-term nature of the actively managed funds industry would make it difficult to do this more than once every five years.

Stunting creativity

“You cannot create an event with fixed income funds,” says the normally cool-tempered Mr Desforges warming to his theme. “It’s always the same product, and it gets boring for investors. Money market products in particular are really the worst. It is very difficult for a distribution network to pick up the phone and tell a client that they have identified a new money market product, as there is so little to talk about.”

Although he is often scathing of what he sees as the tedium and lack of innovation in actively managed mutual funds, Mr Desforges believes there is room for a variety of solutions for retail clients. “If the customer has ?1,000 to invest, they may purchase some life insurance, some mutual funds and structured products in any one quarter. The amount invested is always the same, but the allocation may vary.”

He refuses to acknowledge any real problem in the mis-selling of structured products in Europe, despite well-publicised scandals, resulting from marketing of inappropriate products in the UK, Germany and Belgium. Despite this slightly ruthless streak, he does acknowledge that some products are too complicated for retail investors, and are best confined to their high-net-worth brethren.

“In most cases our products are less risky than ETFs [exchange traded funds],” says Mr Desforges. “And we know that in most cases it is appropriate to sell ETFs to retail clients. Unless specific distributors request highly leveraged products, our offerings are very low risk.

“We are not particularly concerned with the risk of products being mis-sold, providing the distribution network brings examples to clients regarding the redemption mechanism.”