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Study reveals credit crisis has significant Impact on nearly two-thirds of buy-side firms trading equity swaps and OTC options

In a new industry benchmark study by TABB Group, nearly two-thirds of the asset managers interviewed at buy-side firms in the US trading an aggregate of USD 6.35 trillion dollars of assets under management say that the continuing credit crisis is having a significant impact on their trading of over-the-counter (OTC) derivatives.  As many as 57% claim the leading impact of the credit crisis is an increased focus on counterparty risk.  

Over the past 10 years, the demographics covering investment firms with equity derivatives positions expanded rapidly.  "While it may be no surprise that nearly 50% of hedge funds today trade equity swaps or OTC options, a growing number of asset managers, including long-only fundamental shops, indexers and private wealth divisions of regional banks, hold sizable equity derivatives positions as well," writes Adam Sussman (see attached photo), director of research at TABB Group and author of the study, "Equity Swaps and OTC Options 2008: A Buy-side Perspective'.

While lookalike OTC options are used by the same asset managers trading listed options, TABB Group says that nearly 40% of the firms trade exotic options, forecast to rise to 45% by end of year 2009, and that nearly 70% trade total return swaps (TRS). The continuing growth in global equity derivatives, which has experienced a 27% compound annual growth rate (CAGR) across both listed and OTC derivatives since 1999, is being spurred by the buy side's need to create differentiation.

"To access the advantages of equity swaps and OTC options, the buy side must first navigate an opaque market structure," he adds.  While pricing is a key determinant for trading with a firm, "There's little information for the buy side to figure out a fair price."

Sussman warns, however, that heightened awareness of counterparty exposure cannot be overstated.  "Over 50% of all asset managers are tightening the process around measuring and managing counterparty risk.  Large buy-side firms will limit significant exposure to a particular investment bank.  Investment banks are pulling back capital, thus forcing smaller funds to look elsewhere for liquidity and service."  Moving beyond the warning flags, he says "the buy side does agree on at least one thing: the trading and processing of equity swaps and OTC options needs to be more efficient."

"For brokers, the adoption and use of equity swaps and OTC options pose significant opportunities and challenges," adds Andy Nybo, senior analyst and head of TABB Group's derivatives research service. "Bulge-bracket brokers need to build on the strong relationships and broad offering that won them the business in the first place.  Challengers to these brokers will need to make sure that they not only provide the array of critical services, but create differentiation through technology and a value proposition that addresses buy-side concerns."

This research is based on interviews with 32 asset managers, including 17 investment managers and 15 hedge funds, trading an aggregate of USD 6.35 trillion dollars of assets under management.

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