Merrill Lynch has moved emerging market credit derivatives risk to a global, all-encompassing emerging markets book from the structured credit trading book. George Handjinicolau, global head of emerging markets in New York, said the reason behind the move is hard currency emerging market debt, credit derivatives referenced to emerging markets and local currency debt are all country-risk dependent, therefore it makes sense to put these together. "We are adapting our structure to the real world." Both proprietary trading and customer business will be included, as will plain-vanilla and exotic credit derivatives.
This change is the culmination of a three-year investigation into managing emerging market risk. During the 1998 emerging market crises Merrill discovered it had elements of emerging market risk in different sections of the bank. It has decided these would be easier to manage if they were centralized.
Several rival banks put credit derivatives risk in a separate risk book, but traders were split to whether that is the right decision. One trader said there is no point hedging credit derivatives exposure with local currency debt because a sovereign may default on its local currency debt but not its hard currency debt. It therefore makes sense to manage credit risk in a separate book.
Another trader was not familiar with Merrill's plans but said in his own bank emerging market credit derivatives were exceptionally profitable in 1999 and 2000 and managers argued strongly not to have them taken out of their profit and loss accounts. Bankers are less likely to fight to keep emerging market credit risk in their P&L accounts since the bloom has come off emerging markets in the last year, he added.