European institutional investors and banks increased their use of equity derivatives in the first half of 2008, but it is unclear how far the market will be affected by the crisis among
European institutional investors and banks increased their use of equity derivatives in the first half of 2008, but it is unclear how far the market will be affected by the crisis among global banks, says Greenwich Associates.
In addition, while trading volumes of highly liquid ‘flow’ equity derivatives surged last year in North America, the use of structured or securitized equity products fell sharply.
Research by Greenwich Associates found that the European structured or securitized equity derivative products business remains heavily dependent upon the ability of private banks and some institutional clients to on-sell product to retail and high net-worth investors.
According to the results of the 2008 Greenwich Associates European Equity Derivatives Research Study, the notional value of structured or securitized equity derivative products traded in Europe soared by two thirds to a projected USD500bn.
Over the same period, the share of European accounts using these products increased to 82 per cent from 79 per cent.
Jay Bennett, Greenwich Associates consultant, says: ‘European accounts were moving in exactly the opposite direction as their counterparts in North America, many of which stopped using structured equity products as the global liquidity crisis set in.’
Among the most common uses for equity derivatives among European institutions are as an overlay to broaden equity investment strategies and as a means to express directional views on individual stocks, sectors, and markets.
Almost half of European institutions say they use derivatives for one or both of these functions.
More than one in four European accounts also say they employ complex portfolio strategies that include derivatives as core components.
The research also found that more than 55 per cent of banks principally purchase structured equity and securitized products with the intent to on-sell the instruments.
Banks remain the most active users of these products, with over 85 per cent employing them last year.
Despite the strong increase in trading activity across highly liquid ‘flow’ products as a whole, use of options actually decreased among European institutions from 2007 to 2008.
After peaking at 82 per cent in 2006-2007, the use of listed or ‘listed look-alike’ options declined to less than three quarters of accounts from 2007-2008.
The proportion of accounts using single-stock options fell to 58 per cent from 80 per cent and use of index options fell to 60 per cent from 73 per cent.
The use of futures increased slightly, to almost 80 per cent of European institutions from less than three quarters.
Meanwhile, Greenwich Associates’ 2008 North American Equity Derivatives Research Study found that two-thirds of North American institutions use equity derivatives as an overlay to their equity investment strategy.
A further 60 per cent use equity derivatives to express directional views on individual stocks, sectors, or markets and over 40 per cent employ more complex strategies that include equity derivatives as a core component.
Institutions ratcheted up their use of ‘flow’ derivatives products, with commission payments by North American institutional investors on equity options trades soaring some 50 per cent.
In a shift from prior years, however, the proportion of institutions using certain flow products was flat or actually declined year-to-year, even as the volume of trading business was increasing.
The research also shows that in the run-up to the outbreak of the current financial crisis, North American institutional investors were stepping up their use of structured securitized equity derivative products.
As recently as 2006, only 20-25 per cent of investors used these products, but by 2007 that share had jumped to more than 40 per cent.
The trend reversed itself dramatically last year with only 20 per cent of North American institutional investors doing any structured business with equity underlyings from 2007 to 2008.
‘Investors of all types reverted back to simpler, more vanilla trades,’ says Bennett. ‘Regardless of whether this shift turns out to be a cyclical response to market conditions or a more secular turn flowing from this severe market event, it is safe to assume that the growth of this business has been derailed for at least the near term.’
