Features : World’s Best Derivatives Providers 2008



Global Finance’s fifth annual awards for the World’s Best Derivatives Providers come against a backdrop of unprecedented change in financial markets. The long bull market came to an end last year. In its place is a bear market in almost all asset classes—equities, corporate bonds and commodities—and record levels of volatility: Both the Dow Jones Industrial Average and the FTSE 100 suffered their largest point falls ever at the end of September.

Meanwhile, economic growth in the United States and Europe and, increasingly, in the developing world looks set to stall, and the likely impending recession will lead to a sharp contraction in corporate earnings. And, of course, the financial sector—where the troubles began more than a year ago—is moving swiftly from crisis to catastrophe: Banks around the world are folding or being nationalized as their inability to fund themselves becomes life-threatening.

In such turbulent times, derivatives can offer potential opportunities as investors and companies seek to safeguard their assets or profit from falling markets—and some markets appear to be continuing to grow. According to the International Swaps and Derivatives Association (ISDA), the notional amount outstanding of over-the-counter interest rate derivatives grew by nearly 22% to $464.7 trillion from $382.3 trillion in the first half of 2008. Similarly, the notional amount outstanding of equity derivatives grew by 19% to $11.9 trillion from $10 trillion.

However, statistics from the Bank for International Settlements (BIS) indicate a broad retreat in activity on international derivatives exchanges, as opposed to over-the-counter trading, in the second quarter of 2008. According to the BIS, total derivatives turnover based on notional amounts fell to $600 trillion, from $692 trillion in the first quarter—a fall of 13%. Most of this contraction was due to a decline in trading of derivatives on short-term interest rates, although activity in equity and commodity derivatives also fell during the period.

One certain casualty of the financial crisis has been the credit derivatives market, which is widely blamed for spreading the contagion of problems in the US subprime sector to the wider financial markets though credit default swaps and structured products such as collateralized debt obligations. According to ISDA, the notional amount outstanding of credit derivatives decreased by 12% in the first half of 2008 to $54.6 trillion from $62.2 trillion after years of growth.

The explanation for this fall is that the industry is deleveraging and trying to reduce risk “by tearing up economically offsetting transactions,” in the words of ISDA. Despite the decline in activity, the remaining $54.6 trillion is seen by some as a time bomb that could further destabilize the entire financial system. Tighter regulation—and a move away from over-the-counter trading toward centralized clearing—seems increasingly likely.

The future growth trajectory of the derivatives market depends to some extent on its perceived risks. The collapse of institutions such as investment bank Lehman Brothers and near-collapse of titans such as US insurer AIG, which underwrote billions in credit and commodity derivatives contracts, has made counterparty risk a major concern. In some local markets, trading has seized up because of investors’ concerns around creditworthiness. Globally, only banks with solid balance sheets and impeccable credentials can now hope to be participants.

By spotlighting the banks that have garnered the most respect in the derivatives industry in its most difficult year to date, the Global Finance awards for the World’s Best Derivatives Providers are therefore more pertinent than ever. The awards cover each asset class across the three main financial regions of the world—North America, Europe and Asia—as well as overall awards for the best derivatives bank in Latin America and the Middle East and awards for the best exchanges.

The criteria that determine which institutions win Global Finance awards for the World’s Best Derivatives Providers remain the same as in previous years. However, the relative importance of each component—and its characteristics—is inevitably different this year. For example, innovation has always been a crucial component of success in the derivatives market and remains so—although it now largely implies a focus on risk reduction rather than increasing returns. Likewise, the strength and scale of banks has assumed an even greater importance given concerns about counterparty risk. And while competitive pricing remains important, it has perhaps taken a back seat to customer support and execution capability, given less liquid markets.

The information used to select the World’s Best Derivatives Providers comes from a variety of sources, including the opinions of treasurers in each of the five regions and other non-market participants, such as analysts and consultants. Banks in each market were also invited to submit pitches, which were then analyzed by the editorial team at Global Finance and combined with other information sources to pick the best banks in each category.

Laurence Neville