Risk: How would you describe the present use of derivatives in the Nordic markets?
Lars Norup: A significant part of the Nordic derivative markets is the continued extensive use of the basic derivative building blocks, i.e., interest rate swaps, caps, floors and swaptions. This skew towards simplicity seems set to continue in the future - both as a consequence of the credit and liquidity turbulence we have seen since July, and because this is a part of the market that, as the largest Nordic flow derivative house, we are naturally still deeply committed to.
Another key characteristic of the use of derivatives in the Nordic region has been the greatly increased use of derivatives in a broader context than just simple micro-hedges, i.e., using derivatives to reduce the overall profit and loss volatility of a company's bottom line. A similar, much more bespoke use of derivatives has also been in evidence among the financial institutions as well as among institutional investors.
Risk: What is typically the nature of these more tailor-made type transactions?
LN: A number of these hedges have involved hedging the inherent inflation risks of a company's underlying business or combining a hedge of, for example, a company's commodity exposure and linking this to its interest rate risks in such a way that it sacrifices some of its upside in good times for a fundamental 'Pearl Harbor' protection in rough times. Another type of hedging transaction that has been seen over the past year or so in the Nordic region is the use of various market correlations - for example, the linkage between short-term interest rates and the shape of the yield curve. These transactions are also typically designed to benefit the end-user in question when their underlying market conditions deteriorate and, on the other hand, make them pay a slightly higher interest rate when their core business is booming.
Risk: Do you see an increase in speculative as opposed to more hedging-oriented derivative transactions?
LN: In fact, a common theme in most of these transactions is a move away from pure 'casino derivatives' and towards structures that provide a more strategic and macro-oriented hedging combination of the company's economic and financial risks. From many perspectives this is a very welcome trend and one that we at Danske Markets are heavily involved in supporting, both in terms of solutions and research-based cases and analysis, and in continued investments in product development. The fact that the underlying reasoning behind a lot of the abovementioned macro-hedges lends itself very well to more speculative investors goes without saying, and is also important to safeguard and enhance the liquidity in the products.
Risk: Do you find an increased complexity in the structures transacted in the Nordic countries?
LN: We believe it is important to stress that the entire market these days acknowledges that complexity for complexity's sake is a thing of the past. In order for a new derivative structure to make sense it needs to provide characteristics fundamentally different to that which can be achieved using building blocks of first-generation products - otherwise it's just an illiquid, expensive white elephant. In that sense also, the Nordic derivative markets have also grown up and matured, while the product gap that we used to see compared with the London market has narrowed considerably, particularly in the major asset classes.
Risk: Any final observations on the Nordic derivative markets?
LN: The often mentioned much cheaper access to computing power and thus improved quantitative opportunities has also meant that much more detailed analysis and quantification of the various relevant economic correlations and linkages is now feasible. This in turn enables a more tailor made hedging strategy involving the above previously little known parameters. This has indeed been a key reason for the explosive growth in inflation derivatives among several new customer segments across the Nordic countries.
Global Head of Derivative Marketing and Structuring
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