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European buy side expanding equity derivatives business, says Tabb

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Shaking off the frustrating association of blame for the global financial crisis, equity derivatives in Europe are now attracting buy-side traders who have been struggling with laggard volumes, fragmentation in the cash markets and the need for new avenues of alpha.

According to Tabb Group, Europe’s buy side is gearing up for growth and diversity in equity derivatives.

Driven by changes in fund strategies and renewed asset growth providing fresh impetus, Tabb says 71 per cent of buy-side firms expect higher turnover in their main products in 2010.

For some traders, derivatives are a tool to help with efficient housekeeping within a portfolio, explain Miranda Mizen (pictured), principal at Tabb and co-author with analyst Will Rhode of the study, “European Derivatives 2010: The Buy-Side Perspective on Equity Options, Futures and Swaps.”

But for most, they are a necessary port-of-call to demonstrate performance, keep transaction costs to a minimum, maximise alpha and achieve portfolio investment goals efficiently.

Based on interviews with 51 buy-side head traders from asset management firms and hedge funds located in ten of the most developed markets in Europe, over 50 per cent of the buy-side firms have or plan to have Ucits III funds in 2010, and 69 per cent plan to add swaps to the range of new products they will trade.

Although many buy-side traders use equity derivatives only to a limited extent, their interest in greater usage is due to a number of reasons. For many, says Mizen, there is a change of strategy by the fund manager or change of heart from the investor. For others, it is the opening of Ucits III funds and new assets.

Fragmentation in the equities markets puts the ease of trading the top index futures in stark contrast to everything else, despite the lack of both liquidity and range of products, two sources of frustration.

“This means either sticking to a limited range of products or running the gauntlet of illiquidity in the markets and risks associated with an OTC product,” says Mizen.

Counterparty risk concerns have driven activity toward listed products, say the authors, yet liquidity, traders claim, is their major challenge outside the top products. According to Rhode, they would trade more on exchanges if they could, favouring transparency, easy access and protection of clearing capabilities.

“Whether because of difficulty trading the equity markets or the new strategic direction of funds, Tabb Group believes the equity derivatives arena is ripe for progress,” says Mizen. “Trading tools need to keep up as the buy side seeks to improve their electronic quote and trade capture capabilities and speed up straight-through processing, as this is a marketplace where they want to trade more if they can.”

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