Exchange-traded volumes surge

Exchange-traded derivatives had another bumper year in 2005, with a record volume of transactions being logged on both sides of the Atlantic.

Eurex, which is jointly owned by Deutsche Börse and SWX Swiss Exchange, saw the number of trades increase by 17% year-on-year to 1.25 billion contracts, compared with 1.07 billion in 2004.

In the US, both the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME) posted increases in trading volumes. The CBOT saw trading volumes rise by 12.4% to 674 million contracts, while volumes at the CME increased by 24% to 1.05 billion contracts. The figures mark a fourth record year for the CBOT and sixth consecutive annual increase for the CME. All exchanges reported that a higher proportion of trades were conducted electronically.

Meanwhile, Eurex has confirmed it is in talks with a number of rival US-based exchanges about forming a partnership to expand its ailing US business. The exchange agreed that it would seek an external party to acquire a stake in Eurex US, following a supervisory board meeting in January. The move was taken after its parent companies decided to push for a change to the strategic direction of the US exchange last year.

Eurex US has yet to make a profit since it was launched in February 2004 at a cost of €60 million, and has struggled to compete with US rivals. Last year, total trades on Eurex US peaked at 134,000 contracts a day compared with an average of 2.7 million daily contracts traded on the CBOT.

Nybot enters agreement with CBOT

The New York Board of Trade (Nybot) has entered into a non-binding agreement with the Chicago Board of Trade, allowing its financial products to be traded on CBOT's electronic platform.

Frederick Schoenhut, Nybot's chairman, says that the decision provides the financial products with "the tools they need to ensure continued growth in a very competitive market".

The US Dollar Index will start trading electronically as soon as possible, while the remaining financial products will be rolled out by fourth-quarter 2006, says a Nybot spokesman. In 2005, financial futures trading volumes on Nybot's open-outcry trading floor reached record levels – for instance, 3.6 million currency futures contracts traded compared with 2.5 million contracts in 2004.

The hosting agreement is the third the CBOT has entered into with North American grain exchanges following tie-ups with the Kansas City Board of Trade, Minneapolis Grain Exchange and Canada's Winnipeg Commodity Exchange. And in late 2005, it announced that it intends to build an all-electronic commodities exchange in partnership with the Singapore Exchange, called the Joint Asia Derivatives Exchange.

Deutsche launches US commodity ETF

Deutsche Bank has launched the first commodity index-linked fund to be listed on a US stock exchange.

The DB Commodity Index Tracking Fund (DBC) was listed on the American Stock Exchange last month. The fund's returns will track the performance of the Deutsche Bank Liquid Commodity Index – Excess Return, which includes crude oil, heating oil, gold, aluminium, corn and wheat. The index is calculated based on futures contracts on each commodity.

"DBC is designed for investors seeking portfolio diversification and exposure to global commodity returns, which have one of the lowest correlations to US equities and bonds," says Mark Ritter, head of commodities at Deutsche Bank.

Tullett finishes reorganisation

London-based broker Tullett Prebon has completed its reorganisation with the creation of a new division covering several classes of futures and options.

The volatility division will include teams handling global forex options, interest rate options, single-stock and equity index options, and financial futures and options. Most of the 90 members will be based in London, with forex desks in New York, Singapore and Tokyo. The division will be headed by Marcus Bolton.

The reorganisation follows Tullett's acquisition of Prebon Yamane in 2004, and has so far led to more than 300 redundancies from the merged company. Parent company Collins Stewart Tullett estimates the total cost of the reorganisation at £80 million.

Chinese exchange gets go-ahead

The Chinese government has approved a project by five Chinese stock exchanges to set up the country's first financial derivatives exchange in Shanghai.

The exchange will be a joint venture between the Shanghai and Shenzhen stock exchanges, the Shanghai futures exchange and the Dalian and Zhengzhou commodity exchanges, each of which will own 20%.

According to reports in the Chinese newspaper Economic Observer, Fan Fuchun, currently vice-chairman of the China Securities Regulatory Commission, will head the exchange.

The Shanghai, Dalian and Zhengzhou exchanges already permit trading of commodity futures, but China lacks an exchange for trading financial futures. The new exchange will initially list stock index futures, followed by interest rate and currency exchange futures.

Financial derivatives trading was re-legalised in October 2005 after a 10-year ban prompted by a 1995 Treasury bond futures scandal, in which the speculative short-selling of bonds threatened to cause a financial crisis.

Survey shows back office a priority

Dealers devoted greater resources to their operations procedures in 2005, a year in which both the UK Financial Services Authority and the New York Federal Reserve applied regulatory pressure to credit derivatives practitioners over the rapid increase in unconfirmed trades.

All top-tier dealers – defined as those executing more than 2,500 trades a week – now use the Depository Trust & Clearing Corporation (DTCC) for trade-matching, according to a survey conducted by UK-based data provider Markit and Reoch Consulting, a London-based credit derivatives consulting firm.

Overall, it found that 80% of first- and second-tier firms were using the DTCC, compared with 60% in 2004. Average head count in credit operations increased by 25%, while technology investment in operations rose by 33%. Each dealer spent an average of $32.7 million in 2005 compared with $24.6 million in 2004.

Jonathan Davies, Reoch's chief operating officer, says confirmation mismatches in reference entity names are no longer a problem. However, he adds there is still a high number of 'confirmable amendments' – changes to outstanding confirmations – that contributed to the total number of outstanding confirmations. He claims respondents are addressing the problem through greater investment in trade capture systems and the use of data initiatives such as Markit's reference entity database.

Davies adds that 32% of dealers amended their collateralised debt obligation models after the dislocation in the correlation markets in April and May last year. "Up to that point, some dealers and users were incorrectly using tranche correlation rather than implied correlation for mark-to-market and risk management," he says. "This resulted in incorrect deltas and therefore these dealers were incorrectly hedged for large moves in correlation."

Markit and Reoch surveyed 23 dealers for their study.

Algo enters into alliance with Citi

Algorithmics, a Toronto-based specialist in enterprise risk management, has entered into a strategic alliance with global banking giant Citigroup to deliver a global suite of credit risk models. The models will provide credit risk and default analytics for listed and unlisted firms.

These systems have served Citigroup's internal risk management requirements since 1990 and are a result of ongoing research by its risk architecture group. Their default risk analytics will be made available to subscribers of Algorithmics' credit model platform, which will allow them to analyse borrower and counterparty credit quality and to assign internal ratings and validation of internal risk estimates and ratings performance.

Citigroup's suite includes the hybrid probability of default model for listed corporates and financial institutions, which uses market and fundamental financial data to quantify credit risk. The suite also provides access to market-specific credit risk models, which use financial statement data to calculate probability of default and credit grades on listed and unlisted firms and commercial banks.

The two firms claim the alliance will result in "the broadest and deepest credit model solution available in the market", which will cover developed and developing economies in the major regions.

"Making available these market-tested credit models provides our clients with practical tools for enhancing their credit risk measurement and management systems. The alliance with Citigroup is an important part of Algorithmics' broader initiative to provide the market with leading credit risk and capital management offerings," says Michael Zerbs, president and chief operating officer at Algorithmics.

FSA Risk Outlook highlights stress testing

The UK Financial Services Authority (FSA) has warned in its annual Financial Risk Outlook report that the risks to financial stability this year are more weighted towards the downside than in 2005, and has advised banks to improve their stress testing of possible disruptive events.

Sudden events such as a terrorism attack, a global pandemic or a major corporate bankruptcy could cause ripple effects through the financial system. In particular, disruptive events could change long-established correlations between financial instruments and drastically reduce liquidity, making it difficult for investors to sell large positions to minimise losses.

"In these circumstances, it is important that senior managers in financial services firms do not rely on the continuation of the low volatilities and stability of recent years, but instead identify, analyse and test the impact on their firms of differing assumptions, by carrying out effective stress tests, and learning from them," says Callum McCarthy, chairman of the FSA.

Firms are improving stress testing at differing rates, but fully embedding stress testing into banks' risk management processes remains a key challenge. In particular, the FSA says that larger and more complex firms should aim to use aggregated risks in their stress tests, although it concedes that significant (mostly technological) obstacles remain to developing effective methodologies.

Elsewhere, the supervisor said it is still concerned about backlogs in the credit derivatives market. The credit derivatives market grew by 6.85% in September and October last year, while outstanding trade confirmations fell by 4.25%. However, the FSA warns that unsigned confirmations could still pose serious problems in the event of a rise in default rates, and advises banks to further develop the robustness of their back offices.

London Pensions Fund Authority moves to LDI

The London Pensions Fund Authority (LPFA), which manages total net assets of £3.2 billion for local authorities and other public-sector bodies in the UK capital, plans to substantially revamp its investment strategy to make up its pension deficit.

The move follows several corporate pension fund restructurings last year that used liability-driven investment techniques. The most high-profile deal was conducted by UK retailer WH Smith.

While the LPFA has opted to maintain an equity mandate, it has appointed Barclays Global Investors (BGI), European Credit Management (ECM) and Insight Investment, the asset management group of HBOS, to manage cashflow-matching bond and derivatives portfolios, effective January 1. It dispensed with its previous bond mandate managed by Henderson Global Investors.

"Like many pension funds, we suffered a significant drop in our funding level due to our exposure to equities by the time we did our valuation in March 2004," says Peter Scales, chief executive of the LPFA. The assets bottomed out at 74% of liabilities at the end of the equity bear market, and they have since recovered to more than 80%.

"We've now split our strategy into specialist cashflow-matching mandates," adds Scales. "For example, ECM manages a portfolio to deliver a series of liability-matching cashflows with maturities up to 40 years and with an outperformance target of 1.5% over those cashflows. So instead of investing in index-linked bonds and waiting for the redemptions, we've got something far more precisely linked to the cash we need for the payments we make using derivatives structures."

Hugh Carter, a managing director overseeing UK strategic accounts at BGI in London, says it would be employing a mixture of gilts, corporate bonds, credit default swaps, interest rate swaps and inflation swaps to achieve the objectives of its mandate.


On page 68 of the November issue of Risk, we referred to ABN Amro’s Synergy deal as being managed by Access. It was, in fact, managed by France’s Axa Investment Managers

On page 43 of the January issue, the first name of Stuart Lewis, global head of the loan exposure management group at Deutsche Bank was spelled incorrectly.

On page 44 of the January issue, we wrote that Lehman Brothers’ net revenue for 2005 was up 38% to $3.3 billion. This should have read net income. To clarify, Madelyn Antoncic joined Lehman Brothers in 1999, and was appointed as chief risk officer in 2002. There are now 163 employees in the risk division (versus 170 reported), a rise of 42 over 2005 (versus 50 reported).

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