Author: Erik Heinrich

ANNUAL SURVEY / BEST DERIVATIVES PROVIDERS


The fourth annual Global Finance awards for the World’s Best Derivatives Providers comes at a time when derivatives are in the mainstream news as never before. The US subprime mortgage crisis has spawned a credit crunch of unprecedented proportions. Crucially, the contagion from the subprime market to the broader financial markets has occurred largely through the use of credit derivatives and structured products such as collateralized debt obligations (CDOs).

While there have been legitimate concerns raised about the consequences of the CDO market on the lending decisions that were made on US mortgages, the derivatives market itself has emerged largely unscathed from the crisis. After more than a decade when each successive crisis—Barings, Enron and others—has resulted in calls for greater control of the derivatives market, it may be that the industry has reached a level of maturity where the mistakes of a few no longer besmirch the entire market.

The continued staggering growth of derivatives markets indicates the indispensability of a wide range of derivatives products to corporates, investors and banks. For everything from managing stock options programs to insuring against counterparty risk and from controlling the costs of commodities to guarding against volatile FX markets on a day-to-day basis, derivatives are now a central element of mainstream finance.

The figures certainly back up the growing ubiquity of derivatives use. According to the International Swaps and Derivatives Association, the notional amount outstanding of credit derivatives—defined as credit default swaps (CDSs) referencing single names, indexes, baskets and portfolios—grew by 32% in the first six months of 2007 to $45.46 trillion from $34.42 trillion. In the year to the end of June, credit derivatives grew by an astonishing 75% from $26 trillion at the middle of 2006.

In the interest rate derivatives market, which includes interest rate swaps and options and cross-currency swaps, growth has been similarly impressive. The notional amount outstanding of interest rate derivatives grew by 21% to $347.09 trillion from $285.73 trillion in the first half of 2007—up from the 14% growth rate experienced in the second half of 2006. The annual growth rate for interest rate derivatives to mid-2007 was 38% from $250.83 trillion in mid-2006.

Meanwhile, in the equity derivatives market, defined as equity swaps, options and forwards, the notional amount outstanding of equity derivatives increased by 39% from $7.18 trillion to $10.01 trillion in the first half of 2007, an acceleration of the 13% growth enjoyed during the second half of 2006. The annual growth rate for equity derivatives to the end of June 2007 was 57% from the $6.38 trillion recorded at mid-year 2006.

The Global Finance awards for the World’s Best Derivatives Providers spotlight the banks that have garnered the most respect in the derivatives industry—perhaps the most competitive global financial market and certainly the fastest changing and most reliant on innovation. The awards cover each asset class across the three main financial regions of the world—North America, Europe and Asia—as well as an overall award for the best derivatives bank in the Middle East.

The awards reflect the strength of banks in each market, as derivatives by their nature rapidly become a commoditized volume product where scale is vital to success and a strong inter-dealer business is crucial. However, they also reflect the importance of innovation to the development of the markets. In addition, competitive pricing, customer support and execution capability are decisive elements in determining the winners.

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 four regions and other non-market participants such as analysts and consultants. Leading 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.

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NORTH AMERICA

Best Commodity Derivatives Provider  — Morgan Stanley
After 25 years in the business, the breadth and depth of the Morgan Stanley commodities group and its product and geographical coverage is unrivaled. It provides liquidity across asset classes including natural gas, power, emissions, coal, freight and agriculture around the world. And while it is a leader in standardized derivatives instruments, Morgan Stanley also provides specialized swaps and options for less actively traded markets. It also has the wherewithal to quote and manage large volumes and long-term deals.
Morgan Stanley has continued to expand its presence and service offerings in commodities with strategic acquisitions, including US marine transportation and logistics company Heidmar, US fuel supply chain management firm Transmontaigne and carbon credit business MGM in the past year. As well as offering a broad product and geographic reach, Morgan Stanley is focused on delivering exceptional service to its client base, and in October 2006 the commodities group launched a new version of its client link website.

Best Credit Derivatives Provider  — JPMorgan

JPMorgan has faced increased competitive pressure in recent years, with some market observers doubting it could maintain its intellectual and market share lead on investment banking rivals following the departure of a number of JPMorgan alumni to set up similar operations at other banks. This year JPMorgan has shown that its credit derivatives operations are bigger than just the professionals that work there.
As the credit markets have taken a long-expected but nevertheless dramatic turn toward increased volatility, JPMorgan has once against demonstrated leadership in credit derivatives. The liquidity provision and risk management provided by JPMorgan during the recent period of market turmoil is a case in point. JPMorgan continued to provide liquidity and risk transference across all credit products globally throughout the market crisis.
Meanwhile, JPMorgan has been at the forefront of efforts to develop the loan CDS market in both North America and Europe. It is an active participant in working groups to develop the traded loan derivatives markets and helped devise a consistent and usable contract to facilitate increased volumes while addressing issues around loan documentation that had stalled enthusiasm for the market.

Best Equity Derivatives Provider  — BNP Paribas
BNP Paribas has an established expertise in exotic derivatives, but in just 12 months the hedge fund team has become a top-three provider of complex flow solutions while also substantially increasing market share in vanilla products that round out the business and give it greater visibility across markets.
In the 2006 Greenwich Associates poll of 200 leading hedge funds, BNP Paribas was ranked number one in dispersion/correlation trading, number one in overall capability of its flow equity derivatives sales team, number one in quality of execution in customized over-the-counter trades and number one in single-stock variance swaps.
Meanwhile, the bank’s synthetic prime brokerage team and equity finance group in the US has grown significantly in the past year, while systems and operational enhancements have also been made. BNP Paribas is now able to provide portfolio swaps, large single swaps, equity/fixed-income repo, capital optimization, risk management tools, forwards, barrier options and non-US traditional prime brokerage to its clients in the Americas.

Best FX Derivatives Provider  — Citi
Given Citi’s status as the world’s leading bank in just about every segment of corporate North America, it should be a shoo-in as best FX derivatives provider, given the centrality of FX to companies’ funding and business activities. However, surprisingly that has not always been the case, and it is only in the past couple of years that the bank’s investment in technology has paid dividends.
Citi has continued its substantial investment in its electronic trading platform and other technology this year while beefing up research and advisory services and sales and trading to complement them. Consequently, it is for the second year running the best bank in the highly competitive North America FX derivatives market. Citi is determined to bring the best FX derivatives prices to its clients and has built a model focused on volumes to achieve its goal. It has been willing to make a commitment to the market in order to achieve market share and has been rewarded for it.

Best Interest Rate Derivatives Provider — Goldman Sachs

Goldman Sachs aims to be what it describes as a premier liquidity provider: It consistently makes tight markets on a large scale. Given the uncertainty of the rate outlook and for central bank policies, clients are likely to be reassured that the bank will be there with liquidity when they need it regardless of market conditions.
Just as important as the scale of Goldman Sachs’ operation is its dedication to product innovation. The bank is a leader in designing creative solutions to provide efficiency, liquidity and new revenue opportunities for clients, as well as creating value for the bank. One area where Goldman Sachs’ commitment to innovation in interest rate derivatives has yielded strong results is deal-contingent swaps, where the bank has become a leader in the burgeoning market to hedge rate exposure resulting from acquisitions, both for the parties involved and for other market participants.
In the flow derivatives market, Goldman Sachs has committed large amounts of risk capital to its market-making business to enhance an already impressive level of liquidity provision. As a result, the bank has enjoyed a surge in market share and a growth in its client base across all types including hedge funds, corporates, sovereigns, agencies, institutional accounts, commercial banks and pension funds.

EUROPE

Best Commodity Derivatives Provider  — Morgan Stanley
The commodity markets in North America and Europe are closely linked, and it is no surprise that Morgan Stanley occupies a similar leadership position on the both sides of the Atlantic. With its broad range of commodities and related derivative products, the bank is always a leading player and often the bank to beat. It stands out for its ability to offer both volume and tailored products and its willingness to undertake long-term trades.
In July Morgan Stanley demonstrated its strong execution skills when it entered into a long-term agreement to provide a broad range of commodity services to INEOS, the world’s third-largest chemicals company, to support INEOS’s refinery operations in Grangemouth, Scotland, and Lavéra, France. Reflecting the breadth of Morgan Stanley’s global oil sourcing, transportation and marketing network, the agreement covers the supply of crude oil, market-refined products and risk management activities for INEOS’s refining system.

Best Credit Derivatives Provider  — JPMorgan
JPMorgan’s long-standing leadership in credit derivatives in Europe—and the US—is attributable to the breadth of its product offering. It trades the entire range of credit products—bonds, loans, structured products and CDSs—across the whole credit spectrum in both primary and secondary markets and is among the market leaders in all of them. Such a complete range gives JPMorgan great visibility across markets and an ability to bring credit derivatives ideas to fruition rapidly.
In the credit derivatives market, JPMorgan is the number-one liquidity provider in single-name CDSs, indexes, index notes, index options, fixed recovery trading, single-name options and structured products. The bank also has a laudable commitment to the development of the market it helped to create and is involved at all levels in increasing transparency, improving liquidity and improving the knowledge of market participants through the provision of technological tools.

Best Equity Derivatives Provider  — SG CIB
SG CIB’s equity derivatives operation continues to impress. In the past year it has increased its efforts to break down the traditional barriers between investment banking and asset management with the opening of its core trading tools and proprietary strategies for the benefit of all clients. The bank has also maintained its strong ethos of innovation through the creation of the timer call, which—instead of fixing the maturity and letting the volatility float—fixes the volatility and lets the maturity float. The product has reduced call costs for clients and has secured the bank a number-one position among hedge funds.
Geographically, SG CIB has been bold, showing a commitment to developing markets from Croatia to Kazakhstan by helping to educate investors unfamiliar with the potential benefits of equity derivatives. Similarly, the bank has sustained a strong program of editorial partnerships, seminars and web tools that has enabled it to reach out to corporates and investors.

Best FX Derivatives Provider — Deutsche Bank

Deutsche Bank is a market leader in FX and FX derivatives and claims a global market share of 19.3%—just over $24 trillion of activity. In the corporate world, Deutsche Bank has been quick to capitalize on the opportunities of the mid-capitalization-company market. Traditionally such clients have reduced funding costs linked to their cash flows where they had natural exposure and expertise. However, in the current low-volatility environment such structures have become less attractive. In response, Deutsche Bank has created a packaged product that uses the multi-year lows in volatilities to offer good risk/reward optionality and give clients carry opportunities across G-10 and emerging markets currencies in a way that smoothes the volatility of traditional emerging markets investments.
Deutsche Bank has been able to successfully leverage its franchise and understanding of market conditions to provide unique and efficient FX hedging solutions that provide enhanced payoff profiles and market participation without compromising the requirement for hedge accounting compliance. The bank is able to use its financial statements analysis expertise to identify and implement effective approaches for cash-flow and balance-sheet hedging. It maps and quantifies key economic and accounting risks due to FX volatility and identifies key metrics for the companies concerned, such as internal constraints, growth plans and shareholder and investor concerns.

Best Interest Rate Derivatives Provider  — Goldman Sachs
The integration of Goldman Sachs’ interest rate derivatives flow operation, covering governments, mortgages, swaps and options, gives it a critical advantage in the sector by giving it greater visibility and understanding of the rate spectrum. The continued integration of asset classes and subsequent increasing correlation between rate products has provided further leverage to the bank’s market-making business and improved the quality of information flow it has with its clients.
In addition, Goldman Sachs has fully embraced the use of strategists to support its world-class pricing and risk management structures. By integrating the strategists within each trading desk, it is able to provide a quantitative and technological link to the bank’s pricing models and deliver crucial insights that increase the efficiency, accuracy and stability of the rates operation and ultimately benefit clients through more competitive pricing.

ASIA

Best Commodity Derivatives Provider  — SG CIB

SG CIB, a bank with 18 years’ experience in the energy and commodity markets and eight years’ presence in the Asia commodity derivatives market, has significantly boosted its presence in Asia in the past year with its new partnership with the largest bank in Korea, Kookmin. The alliance added to SG CIB’s existing partnership with Mizuho Corporate Bank in Japan for the provision of energy risk management to Japanese corporations, which was set up in 2001, and means that the French bank now has a comprehensive presence in the two most important markets in North Asia.
In Australia, SG CIB is the most active bank trader in the electricity market and is also developing new products such as liquefied natural gas. Across Asia, SG CIB has been adding expertise to its structuring team in order to offer new products. SG CIB’s trade volume in energy and commodities swaps and derivatives in Asia was $40 billion in 2006, and the bank has an admirable client base drawn from airlines, shipping companies, utilities, traders, refiners, producers, end users and financial institutions.
SG CIB has had the foresight to look to new markets: In the past year its carbon emissions trading arm joint venture, Orbeo, has concluded its first major transaction in Asia with an entity, which has not been disclosed, that is one of the largest buyers of carbon credits from overseas emissions reduction projects—representing a substantial step for carbon emissions trading in Asia.

Best Credit Derivatives Provider  — BNP Paribas

BNP Paribas has upped its game in both flow trading, such as CDSs, where it is now one of the top-five CDS dealers in Europe and Asia, and exotic credit derivatives, such as correlation, leverage, hybrid and quanto products. The bank attributes its leadership in the Asian credit derivatives market to its streamlined organization, an integrated trading platform on bond flow CDSs and exotic products and local structuring teams with full execution capability.
BNP Paribas has 30 staff based in Tokyo, Hong Kong and Singapore and claims one of the largest forces in the industry in Asia and Japan. In the flow markets, the bank is a leading liquidity provider in CDSs and cash markets in Japanese, Asian and Australian credits and offers 24-hour CDS pricing on 827 separate credit curves, including 348 in Japan and 479 in the rest of Asia, including Australia, as well as giving its clients the ability to hedge European and US credits in the Asian time zone. BNP Paribas is also the leading price maker in bonds and CDSs in Japan and the rest of Asia, including Australia.

Best Equity Derivatives Provider  — SG CIB
SG CIB’s equity derivatives business in Asia has long been a benchmark of quality in Asia and continues to enjoy exceptional growth in business volumes and a strong record of product innovation and client satisfaction. By leveraging the remarkable equity derivatives strength of SG CIB globally—its equity derivatives revenue is estimated to be €3.45 billion this year, 81% higher than the next largest player in the market—the bank has become a powerhouse with a team of 70 traders, the largest equity derivatives trading team in the region.
The bank also offers the broadest range of products through one of the most extensive trading platforms in Asia. The bank is the only house in Asia offering a full range of equity derivatives products including listed products, flow products and structured products (including structured funds) to all types of investors, including corporates.

Best FX Derivatives Provider  — Deutsche Bank
To become a successful FX derivatives house in Asia requires a balance of local and global innovation and expertise. Deutsche Bank effectively leverages its global FX capabilities with its local structuring and branch network to deliver innovative products to Asian clients. Key to Deutsche Bank’s success is its ability to replicate its dominance in the provision of FX liquidity with an equally impressive position at the more complex end of the market.
The bank’s structuring expertise has driven product innovation across the region with tailored solutions including variations of target profit forwards, which give improved levels on hedging a strip of cash flows. In the corporate liability sector, Deutsche Bank has demonstrated market leadership with funding strategies and funding cost reduction strategies as well as deal-contingent transactions that have benefited from the surge in M&A; activity across the region and the increasing appetite of corporates to hedge against the risks involved in acquisitions.
The bank has also performed some complex FX transactions linked to diversified credit exposures. For example, in one transaction, Deutsche Bank put in place a long-term euro/dollar hedge against both FX and credit risks of a client’s relationship with one of its contractors. That entity had illiquid CDSs, but Deutsche Bank was able to externalize the credit risk using private placements and dynamically hedge its credit position.

Best Interest Rate Derivatives Provider  — Citi
Excellence in interest rate structured products requires an integrated, global and multi-disciplinary product delivery capability. No other firm has an origination footprint, breadth of distribution or execution capacity comparable to Citi. The bank’s strength in interest rate derivatives is reinforced by its position as the top dealer for structured notes across US dollar, euro and yen by volume.
Citi has maintained top positions in the medium-term note private placement league tables in both the number of deals and volumes issued for the past five years, demonstrating a commitment to the structured bond market over the long term. No other house has managed to be placed consistently within the top-five dealers over the same period.
Citi also has invested heavily in new infrastructure and resources to facilitate innovation, whether internally generated or sourced through the market. It focuses both on evolving existing product technologies in order to stay ahead of the competition as well as on the creation of entirely new product families and strategies. Citi’s product suite now includes more than 70 G-3 and local currency products.
The bank is also committed to customer support. Should customers change their view on the market or decide to alter their risk exposure at any time after a structured product transaction, Citi offers a restructuring service—something few rivals do. More generally, Citi has an unrivaled distribution into every major market. Citi is able to sell into virtually every region in Asia and reach the widest possible range of asset managers, pension funds, insurance companies, universities, banks and private banking networks and corporates.

MIDDLE EAST

Best Derivatives Provider  — HSBC
With the Middle East increasingly becoming a center for financial activity, and the region looking to rapidly grow its role in the global economy—most obviously in the area of natural resources but also in booming markets such as Islamic finance—demand for derivatives expertise is growing.
As Middle Eastern companies expand outside the region, they immediately generate a need for FX hedging. Similarly, the increasing level of bond issuance from the region, much of it in Islamic-compliant sukuk form, has created a need for credit derivatives expertise.
International investment banks are inevitably queuing up to offer their services to cash-rich companies looking for derivatives advice. But the Middle East is a conservative market, and reputation and commitment are respected. HSBC not only has a well-established local presence and long-standing connections but also has the global prowess to offer world-class services to companies in the region and a unique insight in the Middle East to international companies looking to expand there.

EXCHANGES

Achievement Award — CME Group
The merger of the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME) in July to create the CME Group is one of the biggest events in the history of exchanges. The combination of two of the world’s leading players has created the world’s largest derivatives exchange, with pro forma 2006 annual revenue of $1.6 billion, average trading volume of approximately 10.2 million contracts a day in second-quarter 2007 and customers from more than 80 countries.
In the last figures the two companies recorded as separate entities—for the second quarter of 2007—both were shown to be entering the merger at the top of their game. The CME recorded a 15% rise in second-quarter profit and a 17% increase in revenue while CBOT’s net income rose 34% and, excluding merger costs, earnings rose 65%. Overall, the combined group had revenues of more than $500 million in the second quarter of 2007. Such strength gives these once bitter rivals a perfect opportunity to accelerate organic growth and, as they have already indicated they will do, go looking for further market consolidation opportunities. Further international consolidation of the derivatives world beckons, and it is a safe bet that the CME Group will play a major role in it.

Performance Award  — Eurex
Deutsche Börse and SWX Swiss Exchange’s Eurex derivatives market has been active in the consolidation of the exchanges market. It announced at the end of April that it would buy the New York-based International Securities Exchange for $2.8 billion, scuppering plans by rivals NYSE Euronext and the CME Group, and the deal is expected to be completed by the end of 2007, creating the largest transatlantic derivatives exchange: Combined, the exchange had an overall trading volume of 2.1 billion contracts in 2006. The deal is expected to result in cost efficiencies of around $50 million and should herald the trading of products from both exchanges across the two continents.
To be sure, Eurex has made some missteps. Its foray into the credit derivatives market with the first exchange-traded product, launched in March 2007, has proved to be unsuccessful to date, with only one bank, SG CIB, supporting it. But in its core market, growth looks unstoppable: In 2006 it achieved a record turnover of more than 1.526 billion contracts compared to 1.25 billion in 2005, making it the largest derivatives exchange in the world by volume. Almost every successive month this year has brought further records: In January the number of contracts traded year-on-year grew 12%, in February contract volume was 26% higher than a year earlier, in March 34%, and in April 24%. With equity market volatility fueling increases in derivatives volumes, Eurex looks certain to have a record 2007.


Erik Heinrich