Tuesday, May 4, 2010

Interest Rate Derivatives, Growth Returns in Flow Products, Users Spurn Non-Vanilla Trades

Original posted on RiskCenter.com by Joan Weber:

Notional trading volume in interest rate derivatives increased by almost 10% globally last year to more than $1.8 trillion. After a year of flat volumes from 2007 to 2008, the past year’s growth was driven largely by a pickup in trading activity among European companies, which account for more than 60% of trading volume worldwide. Volume was also up among companies in the United States as well as among Asian companies, which account for a much smaller share of the global business. Trading volumes declined among government agencies from 2008 to 2009.

Around the world, the use of non-vanilla products declined in credit, equity and interest rate derivatives last year. Only 31% of interest rate derivatives users around the world employed strategic derivatives in 2009, down sharply from the 52% of market participants using them the prior year. Within the group that did use strategic derivatives, the instruments were most commonly employed to manage debt capacity and in balance sheet restructuring/rebalancing. Thirty-six percent of strategic derivatives users in 2009 said they employed the products in a balance sheet restructuring or rebalancing, up from 27% in 2008.

Looking ahead, 42% of companies and government agencies that expect to use strategic derivatives in the coming year say they plan to use them for balance sheet restructuring or rebalancing. “However, only 4% of companies and government agencies that regularly employ interest rate derivatives say they expect to use strategic derivatives in the next 12 months,” says Greenwich Associates consultant Riccardo Cumerlato.

Addressing Counterparty Risk Concerns

Although companies see pricing as the most important factor in assessing dealers and the value they provide, companies are also paying much more attention to dealer creditworthiness, which currently ranks as their number two selection factor overall. “A dealer’s creditworthiness is now considered more important by prospective clients than the quality of its sales team, quoting speed, relationships with senior corporate management or credit terms,” says Greenwich Associates consultant Frank Feenstra.

Although the share of companies expressing serious concerns about counterparty risk in their interest rate derivatives trades declined modestly from 2008 to 2009, 20% of product users say they reduced the amount of business done with individual dealers seen as posing significant levels of counterparty risk, and about a quarter of users employed credit support annexes to manage counterparty risk. Large derivatives users and highly rated companies were most likely to report taking either step.

A Greenwich Market Pulse study conducted in January 2010 revealed that 70% of corporations and financial institutions around the world think moving OTC derivatives trading to a system of centralized clearing would be an effective means of mitigating counterparty risk. “However, financials and corporates also have some serious concerns about the ongoing process of market structure reform,” notes Greenwich Associates consultant Andrew Awad. “Some of these concerns stem from the fact that market participants are uncertain about details of the proposals being considered. Other concerns involve more informed questions among users of OTC derivatives about how the switch to centralized clearing would impact overall market liquidity and costs, as well as corporates’ ability to effectively hedge risk positions.”

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