As interest rates take divergent paths across developed nations and emerging markets, corporations are seeking refuge in derivatives.
If there is one bet that will be especially hard to hedge this year, it is whether interest rates are headed up or down. The expectation that the rest of the world will fall into step when the Federal Reserve Board (Fed) raises or lowers rates seems to have flown out the window.
While the Fed is expected to raise US rates again this year, other developed countries are expected to plumb historic lows. The Bank of Japan is imposing -0.1% interest on some excess reserves. Developing markets are likewise scattered: rates up in China and Mexico, down in Russia and Brazil. The uncertainty is pushing up the forward premium that companies have to pay on foreign exchange markets.
No wonder global investment banks are reporting a steep rise in demand for interest-rate derivatives. At Societe Generale, named this year’s global Best in Interest -Rate Derivatives, sales of these products grew substantially in 2016, making them the biggest contributor to a 42% increase in revenues from fixed income, currencies and commodities trading during the third quarter of last year. Dealers at Societe Generale, which also won the award for Best in Equity Derivatives, receive high marks from corporate clients for a faster-than-average response time.
“Clients need to be mindful of changes in the rates’ market dynamics,” says Antoine Jacquemin, deputy head of Western-Europe foreign exchange and interest-rate derivatives corporate sales at Societe Generale, in Paris. “A number of corporates have adjusted their risk management policy to take into account the current situation.” After the UK voted to secede from the EU in June, many of SG’s clients adjusted their positions in interest-rate derivatives and credit derivatives to reflect the Bank of England’s low-rate stance.
“We expect rates in developed countries to continue to follow a different path as US rates move higher,” says Jacquemin.
The interest-rate scatterplot also spells uncertainty for credit derivatives that are known to be harder to trade at times when asset prices are volatile. That’s why Credit Suisse wins kudos from its clients for keeping its house in order. Looking ahead at Basel III capital requirements that will take effect in 2019, the Swiss bank moved about $5 billion in leverage off its balance sheet by selling an entire portfolio of credit default swaps that were not benchmarked to traded indexes to Citi last year. This year, Credit Suisse, our awardee for Best in Credit Derivatives, is helping its corporate clients contend with new rules on derivatives trading. These rules took effect on March 1, as the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (BCBS-IOSCO) had mandated. The rules govern margins that reflect daily changes in market value in bilateral trades, which are done over the counter; and do not go through clearing- houses, and they can raise the cost of such trades. Now Credit Suisse routinely shows its clients how much it will cost to execute trades in credit options through a clearinghouse rather than trading bilaterally with counterparties—and the impact on their balance sheets.
“It’s our view that, even though there are costs associated with a clearinghouse, the result is ultimately better for the health of the market and its participants,” says Joel Kent, head of Americas flow credit derivatives at Credit Suisse.
More trades are expected to go through clearinghouses this year, which will make trading in credit options more transparent, more standardized and, according to Kent, ultimately more appealing. “As the market evolves toward clearing of options we can see increased demand in that space,” he says. If voluntary clearing becomes more common, he predicts, debt options pricing could reach the point where it becomes as transparent as an index.
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Best Derivatives Providers |
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Best Bank For Equity Derivatives |
Societe Generale |
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Best Bank For Credit Derivatives |
Credit Suisse |
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Best Bank For Interest-Rate Derivatives |
Societe Generale |
