Dividend derivatives: Assessing the Impact of Covid-19

In 2020, the Covid-19 pandemic has completely changed the dividends landscape. Many companies announced their Dividends in February, before the pandemic started. Normally, these dividends would not be expected to change, but in 2020, firms–especially in the banking and insurance sectors–came under both regulatory and political pressure to cancel or reduce their dividends. Roughly, 25% of dividends were cancelled, while around 7% of dividends were significantly reduced in the Euro STOXX 50 index. The 2021 dividends could nevertheless be at the epicentre of the Covid impacts as mainly paid from 2020 earnings. The banking sector resuming dividends despite capped by the European Central Bank (ECB) could offset the further downside risks.

During the first months of the Covid-19 outbreak, the shock was greater on short-term maturities than on long-term maturities. The impact on short-term maturities was driven by, of course, expected economic slowdown and changes in consumer behaviour but also regulatory and political pressure. On top of the change in dividend risk perception, the capitulation of long carry strategies investors, mainly exposed to short to mid-term strategies, drove a sharp spike in the dividend futures beta to the underlying index. The back end of the curve has been following while the market was trying to determine what a recovery will look like and when it may come.

The promising release of preliminary results from a Phase3 vaccine in October last year has been driving expectations of sooner and more effective way out of the lockdown measures and paving the way for a potential faster recovery than previously anticipated.

Investors looking to re-enter the market are positioning themselves on mid-term maturities for a couple of reasons. Resuming containment measures and uncertainty over the effectiveness vaccine distribution is driving uncertainty on short-term maturities in terms of the path to earnings and dividends recovery. The balance of earnings generation and earnings used in the short-term could lead to dividends lagging in the recovery. Some firms are moving from issuing a full dividend payout to a mix of dividends and buybacks. The recovery in terms of dividends could therefore lag the recovery in earnings. Most investors are looking at 2023 and 2024 maturities to avoid the downside risk and idiosyncratic risks on short-term maturities.  

In September 2020, four high yielding banks and telecoms firms, Société Générale, BBVA, Telefonica and Orange, exited the index and were replaced by five lower yielding or non-dividend paying stocks. Further identified reshuffle risk remains but the risks appears more balanced than in previous years.

A major consequence of the pandemic and the dividends movements is the market is likely to see more constant dividend yield structured products instead of price index to try to remove the dividend risk from structured products. The consequence could be a lower risk premium coming from structured product flows. Investors that were previously focused on dividends may shift to a focus on repo, or a mix of the two, as flows will continue to be strong on the repo side. Repo remains a less well-known product than dividends and has larger growth potential. We expect the fast growing open interest in Total Return Futures to continue as they offer an attractive solution to capture the distortion in the repo term structure.

This article was first published on DerivSource on 29 January 2021.

Antoine Deix joined BNP Paribas in 2003 and is currently Senior Equity & Derivatives Strategist for Global Markets, based in Paris. Antoine is a specialist in global repo and dividend derivatives. Having been based in New York from 2004 until 2009, Antoine was first Head of the Dividends and Indices Analysis team, before taking up responsibility for fundamental research within the Forward Trading team.