By Paul J. Davies and Noemie Bisserbe 

France's biggest banks reported substantial trading losses in recent weeks, highlighting the risks they have accumulated selling complex investment products promising high returns when markets are calm.

Société Générale SA and BNP Paribas SA both reported roughly EUR200 million ($216 million) hits to their revenue related to "structured products" the banks cook up for yield-starved clients. During good times, these products can generate substantial fee income for the banks.

But the nature of the coronavirus selloff caught the banks off guard. Most unexpected: The biggest companies on the stock market almost simultaneously made deep and broad cuts to their dividends. Those dividends are a key risk for the banks making those structured products and the sudden cuts led to hefty losses. Société Générale and BNP Paribas said a wave of dividend cancellations by companies as a result of the coronavirus and increased hedging costs were among the causes of their structured-product-linked losses.

The structured-products businesses have been big money earners for French banks in particular, accounting for almost 40% of total equities revenue last year, compared with an average of 14% across the top 10 banks globally, according to research firm Coalition. The risks associated with having such big structured-products businesses appear to weigh on how investors view the banks. BNP Paribas and Société Générale have been among the worst-hit big European financial stocks, both down more than 50% this year. BNP Paribas trades for a third of its book value; Société Générale for 15% of its book value. Big U.S. banks by contrast trade closer to their book value or above.

The main type of structured product that led to the losses at both Société Générale and BNP Paribas are autocallables. These pay a bondlike coupon, so long as the underlying stock-market index they are tied to doesn't rise or fall too much.

French banks are among the biggest creators of these for mom-and-pop investors and wealthy clients. Sales have boomed in recent years and they are especially popular in Asia, hitting nearly $60 billion in South Korea alone last year, according to Structured Retail Products, a specialist industry publication.

But in March's violent market swings, banks suffered pain in part because the complicated way in which they try to guard against potential losses linked to autocallables worked against them. Autocallables are typically tied to the performance of stocks or market indexes. If, say, the Euro Stoxx 50 hits a certain level, the product is "automatically called," meaning the bank repurchases the security at a stated price and investors get their money back.

When banks construct autocallables using stock-options markets, one side effect is an unwanted exposure to corporate dividends, which creates a new risk on their balance sheets. To eliminate that risk, the banks sell dividend futures, a type of derivatives contract.

The problem: When stock markets fall and companies cut dividends, banks have to sell more dividend futures while the value of these is dropping fast. With big banks all selling heavily at the same time, the market moves are amplified causing bigger losses for the banks.

Antoine Deix, equity derivatives strategist at BNP Paribas, said before the Société Générale or BNP Paribas earnings were published that heavy selling by banks accelerated the drop in dividend futures. "When the equity market falls, autocallable structurers [the banks] need to sell more and more dividends," he said. "The more rapidly the market is falling, the more difficult it is to do the hedging those structurers should be doing."

In the Euro Stoxx 50, an index of Europe's biggest companies, popular in autocallable products, dividend expectations crashed more than 50% between late February and the start of April.

For investors to lose out on autocallables, stocks need to drop 40% to 50% below where prices were when the product was sold. The value of the autocallable gets cut down to the low value of stocks at this so-called "knock-in" level and then investors will get this lower value back when their bond matures.

Investors may have had a lucky escape in the recent market rout. The Euro Stoxx 50 dropped more than 38% by mid-March from its late February peak. But like other global indexes, it rebounded almost 17% after central banks started to support the financial system.

"If markets had closed the first quarter at their March lows I suspect a large number of autocallables would have been knocked in," said Russell Clark, portfolio manager at Horseman Capital. "But the rally saved them."

--Julie Steinberg contributed to this article.

Write to Paul J. Davies at and Noemie Bisserbe at


(END) Dow Jones Newswires

May 15, 2020 08:32 ET (12:32 GMT)

Copyright (c) 2020 Dow Jones & Company, Inc.
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