Those companies that have a comprehensive policy of using derivatives range from the large multi nationals down to conservative local corporations and medium sized companies. According to one estimate, usage however is only at about 40% of its potential. "There is still a long way to go," says the derivatives banker speaking off the record.
The banker believes that Singaporean government linked companies have the worst record when it comes to derivative usage, which is ironic given how much Singapore wants to make itself the derivative hub of Asia. Other companies that do not use derivatives nearly enough are the large Chinese companies that are emerging. This is primarily due to the lack of an onshore derivatives market, rather than a lack of demand or sophistication on the part of the clients. Eggelhoefer at Bank of America says his bank is doing derivatives deals with the Hong Kong subsidiaries of the large Chinese companies in Hong Kong. This, he explains, is primarily due to continued lack of clarity in Chinese regulations on derivatives, although Eggelhoefer is encouraged by recent consultations between ISDA and SAFE to review and standardise the ISDA agreement for derivatives in China.
In July, the Chinese authorities released new regulations saying that if any international bank wants to write a derivative contract for a Chinese entity, then that contract has to be booked in China. This new edict appears to cover international derivatives contracts with offshore subsidiaries of Chinese companies and so is quite far reaching. Bankers in the industry suggest it is as much about promoting Shanghai as a financial centre and transferring financial technology as it is about regulating corporate usage of derivatives.
Increased acceptance and in some cases promotion of derivatives by the authorities in Asia is another reason that bankers say their clients are taking to derivatives. To a large degree, Asia was embarrassed by the financial cack-handedness exposed by the crisis. A key response to this has been to deepen the financial products available and encourage their use. "Authorities around the region are keen for their companies to develop good risk management practices and that includes the proper use of derivatives," says Paul Hand at HSBC.
A key player in this didactic process has been the International Swaps and Derivatives Association, or ISDA, to give it its better-known acronym. ISDA is the global professional body of the derivatives industry and is involved in areas such as lobbying, education and standardization of contracts and language.
Angela Papesch runs ISDA's Asia Pacific office in Singapore - which opened in October 2000 - and she notes that for many years, ISDA has been working closely with regulators around the region to help the development of the local derivatives markets. She has also been running seminars for corporates to help them understand the nuances of the derivatives markets and the language of some of the documentation. "We have seen a lot of interest from companies in derivatives," she says.
Despite ISDA's best efforts, regulatory issues remain. Key among the gripes of industry participants is the notion by many regulators that derivatives should be treated as insurance. While empirically this could be argued to be true, practically it restrains market development. Multi jurisdictional approval processes are well known to hinder growth, and banks and corporates always prefer a one stop regulatory process as much as they like one stop banking Thailand is a particular malefactor in this regard, with the insurance regulators demanding oversight of the derivatives industry, confusing the process and preventing the development of the market as a whole.
Interestingly, there appears not to have been any backlash against derivatives in the wake of the financial scandals in the US by regulators in Asia. Many in the market say the collapse of Enron, in particular, exposed what can happen if there are lax risk management tools, rather than an inherent weakness in the derivatives and structured finance market. "I have not seen any backlash post Enron," says ISDA's Papesch. "In fact it is the reverse. Now, many regulators and market participants want to get a true understanding of derivatives, especially credit derivatives."
So is it a bonanza for the banks that are involved in the pulsating derivatives markets in Asia? According to those in the know, no. This is because with the explosion in interest, there has been a massive tightening of the bid-offer spreads on nearly every product available. These spreads - the price differential between what banks will buy and sell derivatives contracts - are where banks usually make most of their money. Now however, the spreads in nearly all exchange traded derivatives are very narrow. This means that for the banks, success lies along the path of excess - size being the determining factor between success and failure in the regional derivatives market.
The banks that have become the main providers of derivatives in Asia are those banks that have both a large on-the-ground local presence as well as big balance sheets. That means that large firms such as Citibank, HSBC, DBS and Standard Chartered tend to dominate the market in the exchange traded and OTC market. They are joined by experts from other institutions such as Deutsche Bank, UBS Warburg and regional players such as DBS. "A bank's ability to be a pan-Asian derivatives house is dependent on its onshore banking franchise," says Hand at HSBC.
Locally, large local banks tend to dominate the game with their international counterparts, revealing that derivatives is as much about balance sheet as it is about product skills. Kookmin in Korea has fast risen to being the number one derivatives house due to the scale of its balance sheet allied to a JV with the derivatives team from Macquarie Bank in Australia. This linkage provides the necessary combination of brains and brawn that is needed in the modern world of derivatives.
Furthermore for those banks that seek to make their money out of innovation, there is very little respect for intellectual capital in the derivatives market. Hand at HSBC reveals that his bank spent four months working on the first constant maturity swap (CMS) to hit the Korean market. Within a week, competitors were hard at work on their own CMS deals. "The Korean market is very quick to adopt new ideas," Hand says.
Overall the corporate market for derivatives is strong. Regulatory encouragement has allied with product developments on the supply side. Demand from corporates is robust and the markets remain liquid. For corporate treasurers seeking to manage the risks in their balance sheets, there are more options - pun intended - than ever before.
