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A tough year with low interest rates and falling equity markets have caused end users to flood into exotic derivatives in an attempt to boost returns for lower premiums, and the landscape is not likely to change this year. "There's definitely been a trend toward more complex all-encompassing derivatives," said Louis Cucciniello, v.p. in global foreign exchange options at JPMorgan in Singapore. "The market has become much more three-dimensional. A few years ago corporates would look at hedging their fx, interest rate and equity risks separately. Now you're seeing structures with fx, interest rate, and perhaps a commodity component or an equity leg," he explained.

Robert Pickel, ceo at theInternational Swaps and Derivatives Association in New York, recounts for DW some of the major events surrounding the over-the-counter derivatives market last year.

Eric Ohayon, head of fx structuring at Lehman Brothers in London, has resigned. Ohayon reported to Mark De Gennaro, global head of fx sales. Jessica Shepherd-Smith, spokeswoman in London, declined to name Ohayon's replacement. Ohayon declined comment and De Gennaro did not return calls.

Vivendi Universal has launched its first earthquake risk catastrophe bond and is believed to be only the second corporation to issue such an instrument. Wayne Cramer, v.p. of global risk management and insurance in New York, said as the financial stability of the insurance and reinsurance sector has continued to deteriorate, the company was looking for another way to offset its risk. "We don't want to be in the business of swapping earthquake risk for credit risk," he said.

Lehman Brothers and Deutsche Bank are recommending foreign exchange trades centered around anticipated changes in levels of implied volatility, but the two firms are focusing on divergent currency pairs. Deutsche Bank is pitching a three-month vol swap to take advantage of cable and euro/dollar having different implied volatilities, while typically they trade at approximately the same level. Lehman Brothers, on the other hand, is pitching a longer-term trade that will pay off if dollar/yen implied volatility rises.

The publication of the 1999 ISDA Credit Derivatives Definitions represented an important step in addressing issues of legal, operational and basis risk in the credit-default swap market. However, since that publication, a series of credit events affecting the relatively limited universe of frequently-traded names has highlighted areas where the 1999 definitions are overly permissive or insufficiently precise. This resulted in the publication by the ISDA Credit Derivatives Market Practice Committee of three supplements, relating to the identification of successors to reference entities, the scope of the insolvency credit event, the treatment of exchangeable and convertible debt securities and, most controversially, the vexed issue of restructuring.

GN Asset Management, the asset management arm of Norwegian banking and insurance group,the Gjensidige NOR Group, with EUR14 billion (USD14.67 billion) under management, is launching two single-strategy hedge funds. The funds both have target sizes of at least USD100 million and will use over-the-counter derivatives, according to Sverre Hope, first v.p. in business development in Lysaker. Hope said the firm already employs these strategies on a small scale, but is offering the funds externally to attract outside investment from pension funds and endowments.

Interest rate derivatives professionals are expecting pension fund managers to resume hedging reinvestment rate guarantees this year, a trend that pushed up swaption volatility two years ago. Sean Notley, head of U.S. and European interest rate derivatives trading at Morgan Stanley in London, expects proposed regulatory and accounting changes in the Netherlands to cause funds to enter the swaps market, much like the changes that caused Danish funds to hedge in 2001. Bankers also expect Swiss funds to join the fray.

Standard & Poor's recent announcement that it considers Qwest Communications International's recent debt restructuring to be a distressed exchange could trigger credit-default swaps, but protection buyers are holding fire on triggering around USD1 billion (notional) in contracts. If Qwest's action is deemed to be a credit event it would be the first case following an optional restructuring, said market watchers. Traders said as soon as one buyer triggers a contract others will follow suit as most Wall Street players do not have directional positions on the name and will be forced to trigger their hedges as soon as buyers trigger swaps the firms have sold to them. If a seller of protection refuses to pay out a New York or English court will likely rule on the issue.

Fischer Francis Trees & Watts is looking to shift up to $300-500 million out of selected banking names in the first quarter in a bid to add yield. Sai Choy, portfolio manager at the $37 billion fixed-income investor, says the firm will look at the new issue market as well as the integrated utility sector, where there may be fresh buying opportunities in the event of further credit erosion.

Gartmore Investment Management, which manages £1.5 billion in sterling- denominated corporate bonds, is seeking to increase its allocation to telecom names and high-yield bonds. Paul Grainger, fund manager for the firm's sterling corporate bond fund in London, says Gartmore has been adding selectively to telecoms and will continue to buy on weakness and volatility. In addition, he will buy high-yield sterling bonds on a name-by-name basis.

The high-grade market looks to be among the best options for bond investors in an overall low-yield environment created by last year's massive Treasury rally, according to several portfolio managers and strategists. They argue that total returns for high-grade bonds will almost certainly be less than last year's 9-10%, they should outperform government securities due to improving corporate credit quality and a reduced supply of new paper.