Volatility and geopolitical events not as linked as they used to be, SRP Americas

Implied volatility across the world in all equity indices is at rock bottom low, despite political uncertainty in Europe, and having such low volatility is not necessarily a good thing for the financial markets, according to panellists at the View from Europe discussion at SRP's sixth annual Americas Wealth Management & Derivatives conference in Boston on June 15.

"Such low volatility in the face of uncertainty encourages companies perhaps to delay investment plans and that of course has the potential to slow the economy," said Shane Edwards, managing director, global head of Structured Solutions, UBS.

Although there still are a number of political events on the horizon, with the German elections scheduled for September and the Italian elections due in March next year, it was the French elections that proved a big turning point for European politics, according to Edwards.

"It was really a consolidatory vote for the European Union, a very strong stand, and that had ramifications in the market," said Edwards. Prior to that vote, for a pretty long time now, and certainly consistently for the last 12 months, US exchange-traded funds (ETFs) were experiencing strong inflows and European focused ETFs were experiencing outflows, according to Edwards.

"That changed straight after the elections. That was a pivotal moment after which we actually started seeing money coming out of US [...] and we have seen positive fund flows heading towards Europe. [The French elections] was a very defining catalyst that altered the course of fund flows," Edwards said.

The elections in France are a good example of the fact that financial markets tend to overreact political risk, said Oumar Diawara (pictured), managing director, Structured Investment Services Platform, Natixis Asset Management. "When we had the polls for the first round of the French election there was a lot of stress because at one point everybody thought that we would have two extremist parties in the second round," said Diawara. "We had a lot of short term volatility but it its more about how, as a structurer, we can leverage this to give a solution to our clients."

Eric Dutruit, managing director, head of Prime & Equity Derivatives Sales, EMEA, HSBC, said what is happening in Europe is truly very interesting and unprecedented. "My view with respect to equity volatility and the geopolitical events that are taken place is that they are not as linked in a global world as they used to be," said Dutruit, noting that the FTSE 100 has been performing very well despite the depreciation and the economical headwinds linked to the Brexit.

"That's partly due to the fact that most companies in the FTSE 100 are international companies not linked to the local GDP, and that's true also for the Dax and the Cac 40."

The geopolitical volatility does not necessarily translate to the local index and the global dynamics of growth has a higher impact on the volatility and how those indices behave, according to Dutruit. "You might have a situation where volatility does not perform and will go back very quickly to a very low base, will jump when there are geopolitical events that happen and have not been anticipated, but will be very difficult to time and to benefit from."

According to Edwards, there is not much difference between the structured products business in Europe and the US. "They are relatively similar to be frank. Most clients these days have become multi-assets and multi-region and with returns being fairly scarces around the world clients have been forced to be quite holistic in their assessment of where they can go and hunt to find alpha," said Edwards.

I think the US and Europe are getting more similar, agreed Dutruit. "If you took the picture 20 years ago, the European market was mainly a savers market," said Dutruit. Around 70% of the financing in Europe is done by banks while in the US it is much more a debt capital market, according to Dutruit. "Historically Europeans were much more looking for capital protected products and bank products because that's how they interact with the capital markets and in the US they were much more direct, equities, ETFs, funds, bonds and municipals and so on. But it's changing and that's partly due to the fact that quantitative easing is now the same across G7."

Between the two markets, in Europe there tend to be more structured products on different underlyings, said Diawara while, according to Edwards, one of the big themes, especially among investors in Hong Kong aqnd Japan, is the trading of US stocks. "It is quite hard to find anything with high volatility these days and a lot of our client base, through structured products, likes to be implicitly selling implied volatility that earned coupons and they gravitate quite a lot around the US single stock landscape," said Edwards who noted that in terms of business, volumes have generally been very good through the course of the year.

"I think this is a vote of confidence from the investor base, perhaps on the back of the Trump trade, perhaps on the back of inflation and various other bits and pieces. A big part of the growth in business these days is really solutions oriented," said Edwards. "A lot of our client base, particularly in the institutional arena, has various regulatory challenges and tries to get a square peg in a round hole, one way or another, obviously in a compliant and fully legal way."

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