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GKN Plc, a manufacturer of automotive engines and components, is considering entering an interest rate swap to convert a recent GBP125 million (USD201.50 million) offering into a synthetic floating-rate liability. The company will make a decision shortly, said Derek Butler, head of treasury in Redditch, U.K. But, he declined to detail what will influence its decision. If GKN goes ahead with the plans it would enter a swap in which it receives the 7% fixed coupon on the bond and pays a floating rate.

Investors Turn To Exotics In Times Of Trouble

Hybrids Expected To Top New Year Shopping Lists

INVESCO, BlackRock, Barclays Global Investors and Blackstone, which were separately planning to bring their first managed synthetic collateralized debt obligations to market last year, have reportedly postponed the deals because of adverse market conditions. BGI has shelved plans to manage its first CDO in the U.S. because of a lack of investor appetite and tight credit spreads, according to Tom Taggart, spokesman in San Francisco. The deal was scheduled to be priced in the summer (DW, 5/19) was postponed and then cancelled. An official from Blackrock in New York said the firm has structured its first synthetic CDO but is waiting for better arbitrage opportunities between the asset and liabilities side of the deal. One official said those opportunities are likely to resurface when insurance companies clarify their long-term commitment to the CDO market. He expects this to happen in the coming weeks. Bill Hensel, spokesman at AMVESCAP, INVESCO's parent firm in Atlanta, Ga., declined comment and Christine Hadlow, spokeswoman at Blackstone in New York, didn't return calls by press time.

The 2002 definitions are based on the 1996 International Swaps and Derivatives Association's equity derivatives definitions and, like the 1996 definitions, are primarily intended to be incorporated into confirmations documenting equity derivatives transactions. Trades executed under the 1996 definitions will not, without further action by the parties, be affected by the adoption of the new definitions. This article will discuss the key areas in which the 2002 definitions modify the 1996 version, including the expansion of product coverage, separation of settlement mechanics from product type, expansion of the consequences of merger and other events impacting the underlying shares and refinement of the consequences of market disruptions. Like the 1996 definitions, the 2002 definitions are intended to reflect a global standard of current market practice and are not necessarily meant to deal with issues that only relate to certain specific jurisdictions.

The Asian structured credit derivatives market is expected to break more of its ties with its European and U.S. equivalents, a trend which, although started last year, has a long way to go. The first synthetic collateralized debt obligations referenced entirely to Asian credits was launched by Société Générale Asia last year and totaled USD100 million. BNP Paribas was hot on its French rivals heels and started working on its first Asian dominated CDO in February (DW, 2/25). Gilbert Tse, managing director and head of structured credit derivatives at SG in Hong Kong, said, "I think we'll see a lot more CDOs with some or more Asian contents this year." Guillaume Dieu, director and head of Asia Pacific synthetic securitization at BNP in Hong Kong, said the products are popular because of the diversification they offer CDO investors who already have CDOs referenced to European or U.S. credits.

Money managers have started using credit derivatives to hedge and boost returns for institutional clients and are expected to start using the instruments for retail portfolios this year. Schroder Investment Management is thought to be the first large asset manager to use credit derivatives for retail targeted portfolios, (DW, 12/1) but last year, U.S. asset management giants Western Asset (WAMCO), Fidelity Investments and JPMorgan Fleming Asset Management all staged their entrance into the credit derivatives arena, said credit derivatives sales professionals.

Convertible arbitrage hedge funds are searching out ways of reducing credit risk while avoiding the high premiums associated with the credit-default swap mart, and some think equity derivatives are the answer. One of KBC Alternative Investment Management's convertible arb funds started using deep out-of-the-money equity puts to hedge against bankruptcy risk on convertible bond exposure last year and bankers predict this technique will spread this year.

Investment banks let go staff across the board, but the cuts in derivatives were deepest in Asia as firms moved to eliminate duplication. Next year headhunters and staffers expect to see derivatives houses' centralizing their trading operations to reduce back-office headcount, a trend that started last year. In fact, in 2002 some firms, such as Bank of America, closed down whole operations, while others, such as Goldman Sachs, centralized all their traders in one Asian location.

Invesco Global, the European and Asian arm of Invesco Asset Management, plans to use over-the-counter foreign exchange derivatives in its first long/short equity hedge fund for non-U.S. investors. The fund, which began trading last month, currently uses exchange-traded futures, said Brett Bastin, head of product development for absolute return strategies in London. It has a long/short large cap focus and then uses futures as an overlay to gain exposure to movements in the U.S. bond market and the Standard & Poor's 500. Because it includes non-U.S. investors, currency options will be used for hedging purposes. As the fund grows it will start using OTC options, as well as continuing to use listed options, for currency hedging.

Hybrid structured products across all derivatives asset classes will likely continue to grow in popularity throughout the year, as both institutional and retail investors scour the market for investments that will beat depressed equity investments. Rhomais Ram, director at Deutsche Bank in London, said he is seeing investors become more savvy with using foreign exchange spot and options as investment instruments in themselves, rather than hedging tools, a trend that should make marketing of hybrid products easier.