Structured stagnation

Editor's letter

Asia's buoyant structured products market - at least in the case of investments linked to equity - has ground to a virtual standstill. The development is far from unexpected. It appeared inevitable to Asia Risk in December, as noted in this column, that something in the markets had to give: either liquidity must return to the funding and credit markets or equities would take a hit.

Unfortunately for dealers, already reeling from the collapse of their lucrative revenues from ramped-up structured credit business units - with the exception of the small number picking up distressed credit assets at fire-sale prices - the timing of the equity market downturn couldn't be much worse.

January has proven disastrous, especially for those dealers that had relaxed into cruise-control after the booming performance of their structured products business in the past three years. Some parties reckon volumes are trading at as little as 10% of those witnessed this time last year - although others cite much higher figures. With everybody's 2008 financial budgets higher compared with last year and Asian performance expected, in many cases, to plug the shortfall in European and US profits, making up even the first-quarter shortfalls may prove difficult.

Private banks, too, are facing problems, and not just due to lost profits from clients no longer rolling their equity structured products such as accumulators and range accruals. They have also had to make tough decisions about margin calls linked to client positions - and some of their exposures are not entirely clear, as their systems have had difficulties tracking all positions in real time. This may not sit well with regional tycoons, some of their most important clients.

And the problems don't end there. The trading positions at leading dealers of structured products are also in jeopardy. Due to the high concentrations of underlyings referenced to Asian structured products, dealers' positions are in a fragile state. Most of them are short correlation at a time when hedge funds are showing an increasing reluctance to trade dispersion - via variance swaps - and longer-dated, more bespoke correlation swap positions, which tend to be used to ease these book axe positions.

The next couple of months will define the institutions that will benefit from a rapid correction in the price of volatility. That said, thus far, nobody has shown any real signs of panic.

By Christopher Jeffery.

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