E.U. institutions expect more OTC trade

Wednesday, November 9, 2011 Stamford, CT USA — European institutions expect to increase their use of equity options and swaps in the coming year — a rebound that would help make up for a slowdown in trading activity in these products during mid-year 2011. European institutions appear to be gearing up for an even bigger increase in the use of structured OTC equity/securitized products as institutional and end retail investors regain their appetite for more structured products.

Sixty percent of European institutions participating in Greenwich Associates 2011 European Equity Derivatives study expect to increase their use of equity options in the coming year and 30% expect to step up their use of equity swaps. Since fewer than 5% of institutions predict a significant decline in the use of these products, it appears that market participants interviewed in May and June of this year entered the second half of 2011 primed for a pick up in trading activity following a year of disappointing trading volumes.

"Since these products have now been fully integrated into the equity investment process, trading activity in options and swaps is largely determined by the same macro trends influencing market activity in cash equities," says Greenwich Associates consultant Jay Bennett. "Because global stock markets throughout the period covered in our research were characterized by depressed trading activity brought on by a lack of investor conviction that left cash on the sidelines, equity derivatives trading slowed in step. This may have changed given extreme volatility and market activity over the past month."

Trading Activity: Slowdown in Options, Futures and Swaps
The typical European institution paid approximately $2.6 million in commissions on equity option trades and approximately $1.9 million in cleaning and execution commissions on futures trades in the 12 months ending May-June 2011. On average, individual institutions reported notional trading volumes of $380 million in equity swaps during the period. Institutions paid an average $950,000 in commissions on ETF trades over this time frame. "At an aggregate level, our data show a decline of roughly 25% from 2010 to 2011 in the commission pool on options and futures, indicating a proportional slowdown in institutional trading volume in these products" says Greenwich Associates consultant John Colon. "We estimate a decline in swaps trading activity of about 20% for the period."

Structured OTC Equity/Securitized Products: A Return of Counterparty Risk?
Sixty percent of institutions active in structured OTC equity/securitized products expect to increase their use of these products in the year ahead, including 14% saying they expect to increase their use "significantly."

As they become more active in these products, institutions will be keeping a close eye on developments in the European banking sector. Coming into the summer of 2011, concerns about counterparty strength and liquidity had apparently begun to recede into the memories of many European users of structured OTC equity/securitized products. The share of these institutions citing counterparty creditworthiness as an important factor when selecting a broker for a trade in these products plunged to just 37% in 2011 from a full 61% the prior year. As recently as 2009, 29% of European institutions said they ranked brokers' willingness to provide liquidity as an important consideration in picking a broker. That share dropped to 17% in 2011 from 20% in 2010. In place of these criteria, institutions are placing greater emphasis on the expertise of brokers' sales professionals and firms' understanding of institutional investment strategies and hedging needs.

"We suspect that these attitudes have already changed since we conducted our interviews — and if they haven't changed yet, they will soon," says Jay Bennett. "The past banking crisis brought this business to a halt and elevated concerns about counterparty risk and access to liquidity. With a new crisis possibly beginning to unfold among banks, institutions are likely to re-emphasize assessments of counterparty strength and liquidity provision for the year to come."

Greenwich Share and Quality Leaders
Deutsche Bank leads a crowded field at the top of the market in European flow equity derivatives trading. Deutsche is named as an important flow equity derivatives relationship by 59% of European institutions active in this market, just ahead of J.P. Morgan and Morgan Stanley, each of which have achieved market penetration scores of 50-51%. These firms are among the six 2011 Greenwich Share Leaders in European Flow Equity Derivatives. Separately Deutsche Bank and Morgan Stanley are the joint 2011 Greenwich Quality Leaders across these delta one, options and other volatility products.
BNP Paribas leads the field in structured OTC equity/securitized products with a market-best relationship penetration score of 42%. BNP Paribas joins J.P. Morgan, SG IB and UBS as the 2011 Greenwich Quality Leaders in European Structured OTC Equity/Securitized Products.

Firms cited as Greenwich Quality Leaders have distinguished themselves from their competitors through client quality ratings that exceed those of competitors by a statistically significant margin.

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