Stuart Fieldhouse
Originally published in the May 2005 issue

What is going on at Nomura? The bank has been on a hiring spree since last summer, recruiting very specific personnel for its new structured products and equity derivatives business. Over 50 hires have been made since last summer, mostly for its London base, although there have been some recruits in Asia and the Middle East as well.

Not a bank that has made a huge impact in the European hedge funds space to date, the Japanese giant now seems intent on changing that. Although not one of the A-list hedge fund prime brokers, Nomura has taken the decision to enter the market in a very specialised, and highly sophisticated manner, challenging for a position as a top provider of structured solutions and equity-derivatives.

"The aim," says Joachim Willnow, the new Head of Equity Derivatives at Nomura International, "is to build a cutting edge capability that will make Nomura a market leader in structured products."

As an ambition this is eminently achievable for a bank of Nomura's size. The decision to move into the business of building structured solutions was a strategic one, taken by the bank's Tokyo headquarters. Following that decision, it has been out in the marketplace selecting the people it needs to make this happen.

Willnow, who joined Nomura in July 2004 from Merrill Lynch, has grown his team to include such key players as Marco Mocquard and Mike Fullalove as well as other specialists from institutions like Société Générale, JP Morgan and ABN Amro. In short, Nomura has been assembling a team of stars to take its vision forward. "The standards of this industry have required quite a senior team," Willnow says. "We're trying to differentiate ourselves by marrying the benefits of the asset management world with the benefits of the trading world. Asset management is traditionally more relationship-driven, less deal-driven. On the trading floors, by contrast, there is more a culture of product innovation driven from the constant need for quicker, more effective solutions."

In order to build its foundations in asset management structures and fund derivatives, the bank has started from a small in-house team, and hired experts from houses like Morgan Stanley Investment Managers and Henderson for their fund management expertise. The new business was being created with a strong European and Middle Eastern bias initially, although a team headed by John Robson, formerly from Merrill Lynch, is already in place in Hong Kong as well, with expansion to the New York team being looked at as the next step.

This process has seen Nomura hire personnel in the equities derivatives business from no less than 14 banks, and product development specialists from five institutions. It has been a strategy based on understanding the needs of the market and seeing who best could meet those needs.

Alongside Willnow is Mike Fullalove, Managing Director responsible for product development and fund derivatives. Fullalove is being tasked with the international (ex-Japan) product development brief, and is drawing on almost a decade of experience in structuring fund and derivative products at Merrill Lynch and Goldman Sachs.

Also leading the team is Marco Mocquard, running the trading side of the equity derivatives business. He accompanied Willnow and Fullalove from Merrill, where he was co-head of the equity structured solutions group, and has a strong trackrecord in trading equity derivatives.

Staying focused

When asked where they see their competition in the flow trading space, Mocquard responds, "Rather than just delivering traditional solutions to equity derivatives, Nomura is going to focus on providing strong access to the mid-cap single stock and index space, as well as delivering on the underlyings that our clients want. It is not going to spread itself too wide. Based on our approach, we feel we've differentiated ourself from the competition. We're ready to prove this. No-one else has our focus to the same degree today – most investment banks will have each trader quote on more than 25-30 stocks. We're concentrating on a smaller number of stocks and, through our market-making team, are able to provide liquidity for our clients where there was a lot less."

On a more general level, Nomura is lining up against the likes of SocGen, which acquired the structured solutions business of Bank of America, and BNP Paribas, which added to its own internal capabilities when it acquired the struggling Zurich Capital Markets in 2004.

"When it comes to fund derivatives, we're looking at the business in a different way from our competitors," Fullalove says. "Funds are our biggest focus, and we can deliver both the fund derivatives and the wrappers that investors are looking to buy."

The bank is creating guaranteed products to sell to investors, but is also in the financing space, providing fund of funds with the opportunity to create a leveraged share class, for instance. Building a fund derivatives business alongside its structured solutions capability enables Nomura to work both sides of the business.

"We've got the advantage of building a business from scratch with experienced people," Willnow explains. "We know we can cope with the requests clients make and avoid mistakes that are common in institutions that have less developed systems."

"To do this effectively has required the development of sophisticated sales tools, like our CPPI pricing model, that allows clients to come to us without defined requirements for a structure in place, and we then can help them change and refine their request until we achieve the product they need; thus, improving their payoff profiles. This has included detailed scenario analyses, and has prompted positive feedback from the industry already. We're here to innovate," Fullalove says, "not just at the payoff profile level, but also at the platform or fund level."

"Looking at the market, we felt that in order to be competitive we needed to deliver a two- tiered approach to fund derivatives within product development. We're talking to the fund of funds directly to understand their needs, and we're structuring better wrappers for the distributors.

A key theme right now is that fund of funds and hedge funds are seeing the market mature. They need structured products specialists to partner with, and are looking to raise assets from the non-alternative side. For example, some are exploring ways to develop guaranteed hedge fund products to sell to retail investors in Europe. Fund of funds want to have larger client bases, and they need key partners to help them to achieve this," says Fullalove.

The bank is already in the process of setting-up fund platforms in Guernsey, Dublin, and Luxembourg, which has necessitated considerable investment in the in-house legal and tax expertise to make this kind of business work. At this level, specialised players like Nomura can find themselves exploring new frontiers, from both a tax and regulatory perspective.

"We're talking to funds of funds directly, and we're finding that they're getting to quite a mature stage."

"We've got experts here who've spent 10 years auditing hedge funds and funds of funds," Fullalove says. "From a regulatory perspective, we think it's important to be as transparent as possible. Since we've been here, the FSA and other regulators have been in to see the business, so that they can understand the level of experience of the people we have here. They appreciate the explanations we are able to give them."

A new bank in the business

Building a successful structured solutions business requires a number of critical ingredients: experienced people, heavy investment (for e.g. in in-house legal and tax expertise), and a committed parent. Nomura is a large, Japanese-focused firm with global expansion ambitions. It has put a lot of effort into building the best business possible, focusing on creating a strong team, good systems, transparency with regulators and a solid balance sheet: its bonds and credit default swaps can trade at AA levels, and they are trading tighter than a lot of investment banks.

"In July 2004, we got upgraded," says Fullalove. "We are flexible in the type of structure we produce, a number of products in our pipeline are Nomura issued, but one deal we are working on is being issued by a third party. Our structures and terms are often in response to the needs of an individual client."

Go to Japan, where the bank is AA-rated by the local agencies, and you will see the country's largest banking brand, with a 26% market share in fixed income alone. "In Japan you cannot have a better brand," Mocquard says.

The bank includes a network of 5,000 consultants in Japan alone, and a distribution capability that could be of great value to both hedge funds and fund of funds seeking access to what is potentially a massive market for alternative investment products.

Funds specialists

Fullalove is keen to emphasise the fund-focused side of the business, and the fact that Nomura is creating a team here that merges the equity derivatives and structured products specialisation one would equate with a seasoned investment banking operation, with the knowledge of the institutional investment marketplace that would be found in a big asset management house. For example, the bank has hired a former pension funds consultant to look at how value can be added via fund selection. Nomura is speaking with institutional investors, like pension funds, which are either already invested in the alternatives space, or are seriously thinking about it.

Considering the large degree of scepticism with which hedge funds are still treated in the pension funds market, the structures that Nomura is proposing could be a means for funds of funds to enhance their attractiveness. The bank certainly seems to be investing a lot of time and effort in making sure it understands this market.

"Nomura has a deep specialisation on the funds side," Willnow explains. "We've got people with a range of funds experience, which allows us to structure, price and execute transactions quickly. We've also got a strong due diligence process, and strong relationships with the fund managers themselves. In terms of pricing capacities, the system we're using allows us to price the underlying funds effectively, and it allows us to provide a larger degree of liquidity, potentially more than the underlying funds themselves."

Mocquard's end of the business involves working with hedge fund managers to provide them with the equity derivatives products their strategies require: Nomura is focusing on mid-cap stocks, he says. "We're currently asking clients what they want," says Mocquard. "For example, in the mid-caps space we focus on providing access to the stocks and indices our clients need, and this is much appreciated by hedge fund managers. We're seeing a large deal flow from managers who want to trade on the names we can provide. They appreciate the liquidity we provide through our market-making desk."

"The big challenge, Mocquard reckons, is the change of mentality this focused approach asks of his team."

This list of stocks on which Nomura is pricing contracts is updated roughly once a fortnight. "Interest is being driven by big events," Mocquard says. "If our goal was to cover a much larger number of stocks, it wouldn't work. We have to look more closely at the fundamentals. Our traders need to be able to take a view and respond quickly to the market."

Nomura is also issuing index derivatives based on European single-country indexes, and has a decent market share around the IBEX and MDAX.

The big challenge, Mocquard reckons, is the change of mentality this focused approach asks of his team. If you have been in the business for 10 years, and have serviced the big mutual funds, one might expect a broad coverage on the equity derivatives front that would encompass, say, 150 stocks. Yet Nomura is finding appreciation for its choice of tack, namely a highly focused, specialised approach, pricing structures from plain vanilla to some of the more exotic structures on the market, including most underlyings.

"Most hedge funds require plain vanilla products," Mocquard adds, "mainly calls, puts, swaps, and dispersion trades."

Where to now?

Where to now that the business is up and running? At the moment Fullalove's product development team is focusing on the hedge fund and asset management end of the business, mainly in Europe, the Middle East and Asia ex-Japan. A big effort in the American market is on the cards for later in the year.

Most of the production engine is sited in London, with some sales, trading, and product development occurring in Hong Kong, Madrid, New York and Bahrain. London is also providing some coverage of non-Japanese instruments for the parent bank in Tokyo.

"The Nomura board has shown tremendous support for the whole initiative," says Willnow, recognising that it will be the on-going commitment of the bank's senior management that will help to drive the business forward.

Nomura has built a credit business and interest rate derivatives operation, but it was a strategic decision to move into the equity derivatives business. Banks that have lost interest in this space have been able to sell-on their fund solutions businesses to other players, but in Nomura's case, with its strong credit rating, investment banking expertise, and the ability to deliver to the industry solutions at a number of levels, it is well positioned to become a considerable force in the European hedge funds market for the first time.