A liquid correlation derivatives market encompassing a range of asset classes is likely to emerge in the coming three-to-five years, according to Sydney-based derivatives author and consultant Satyajit Das. "This would allow corporates to reduce their hedging costs and provide end investors with new types of risk and trading opportunities," said Das, a former treasurer at Australia's TNT Group, and derivatives banker at Commonwealth Bank of Australia, Citigroup, and Merrill Lynch.
An example product would be a commodity producer hedging falling commodity prices while protecting against rate hikes via buying an interest rate cap linked to the commodity. If the commodity price rises to a certain level the interest rate cap is knocked-out, thereby using correlation to reduce the cost of hedging. "You're really trying to maximize net income," he added, noting that companies could hedge assets in groups at lower premiums, rather than individually at a higher cost.
The beginnings of the market have already begun to emerge, for instance Deutsche Bank set up a correlation trading desk within in its global commodities business last year (DW, 3/24). Market officials, however, noted that a fully-blown market is some way off.
Masahiro Hosomi, general manager of the business development office at Mitsubishi Securities and International Swaps and Derivatives Association board member in Tokyo, agrees that this could become a major OTC market. "Many large blue chip companies, such as airlines, are regular users of derivatives, especially commodity derivatives. Oil prices, fx and interest rates are important factors that need to be hedged--a correlation market could be useful." he said.
"This concept is definitely on the cards," said Ken Farrow, chief executive of the Australian Financial Markets Association in Sydney, adding,
Anita Fung, treasurer and co-head of global markets at HSBC in Hong Kong, warned that while such a market is possible, the correlated assets must be compelling enough to attract liquidity.