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The use of sophisticated risk management tools is being rapidly adopted in the investment management industry. We view this trend as natural given that asset managers are in the business of taking risk. In other words, whether their mandate is to fund contingent liabilities, such as pension funds, produce excess returns over a benchmark, such as traditional asset managers, or generate exceptional absolute returns, such as hedge funds, asset managers need to assume risk in order to meet their objectives.

Norwegian state-owned utility Statkraft is considering making its first major use of over-the-counter derivatives to hedge weather-related risks. An official in Oslo said the state owned utility has significant exposure to fluctuations in rainfall because it is the country's leading hydroelectric producer. "We have a mean production of 33 TW/h per year of hydro production, which can be affected by both precipitation and temperature and can vary a lot," the official explained. Statkraft is considering using weather derivatives now because the market is becoming more liquid. "Our approach is that we have weather risk and so a part of risk management is to consider whether that can be hedged and what is the cost," he said. "Our experience so far is that it has been too expensive."

An increase in the volume of plain-vanilla and structured credit products in 2001 has moved the Asian credit derivatives market another step closer to the depth and sophistication of the European and U.S. markets. One major innovation last year was the structuring of the first synthetic CDOs referenced solely to Japanese names, by firms such as BNP Paribas, J.P. Morgan and Deutsche Bank (DW, 11/19).

The foreign exchange market in 2001 remained largely indifferent to the kind of sweeping macroeconomic movements and exogenous shocks that in different times would have sent spot and implied volatility on a roller coaster ride. As a result, the fx markets were "a really boring place to be this year," according to one options trader.

"The clock is ticking the wrong way."--Thor Lien, managing director of Enron Nordic Energy in Oslo, commenting on the amount of time the company has to find a buyer (DW, 12/3).

Grand Cathay Securities Corp. and Yuanta Core Pacific Securities Co. recently separately received licenses from the Securities and Futures Commission to act as market makers in Taiwan dollar interest-rate swaps, a move that officials believe will bolster the market. Grand Cathay and Yuanta are the first domestic securities houses to receive such licenses. "This should boost volumes by 20-30% within six months", said Samuel Wang, manager of the derivatives department at Yuanta in Taipei.

Capital-protected products structured with derivatives dominated the Asian equity market last year as investors looked for a silver lining amid slumping cash equity and interest rate markets. "The major trend for the year was capital-guaranteed notes and funds," said Alan Loh, managing director and Asia Pacific (ex-Japan) co-head of equity derivatives at Deutsche Bank in Hong Kong. Harold Kim, managing director of Asia Pacific equity derivatives at Salomon Smith Barney in Hong Kong, agreed, noting that "Markets were generally weak, nervous and volatile. These conditions hurt demand for bull-market products, however, these same conditions are good for capital-guaranteed products." James Rodríguez de Castro, managing director of global equity-linked products at Merrill Lynch in Hong Kong, attributed part of the increase in demand to local banks pitching these structures to retail clients. Merrill offered the first exchange-listed equity-linked notes in Singapore dollars earlier this year (DW, 7/29). Warrants structured on baskets of Chinese B shares were also popular in Asia last year. Credit Lyonnais in Hong Kong revived these instruments after pioneering the product four years ago (DW, 6/11).

Credit-default spreads on European telecoms moved tighter last week, lead by France Telecom, as investors put New Year's cash to work in the liquid telecom sector. Five-year protection on France Telecom tightened roughly 10 basis points to 165-175bps by Thursday in London. Other European names such as British Telecommunications and Deutsche Telekom moved in about half that amount to 87-97bps and 93-103bps, respectively. Traders said the move in the default swap market mirrored the cash market, where investors put cash to work at the start of the new year before primary issuance has materialized. "Investors get flat toward the end of the year, so now they have cash to spend and nothing to spend it on," said one default swap trader, adding, "telecoms are the most liquid: you can get in and out."

Thai Farmers Asset Management, the asset management arm of Thai Farmers Bank with over THB130 billion (USD2.9 billion) under management, is looking to pull the trigger on its first derivative contract in the next few weeks, eyeing such products as asset-swaps and credit-linked notes. "We're looking at new possibilities to enhance returns," said Yingyong Nilasena, first senior v.p. of fixed income in Bangkok. The asset manager has conducted research into derivatives products over the last year and has been discussing with regulators which instruments it is permitted to use. The fixed-income fund is not permitted to invest outright in convertibles but Thailand's Securities and Exchange Commission allows such funds to invest in the debt portion if they strip out the equity component with derivatives.

The search for yield-enhancing products dominated the Asian interest-rate markets this year and acted as a catalyst for innovation. "For liability management, we started to see interest in products such as constant-maturity swaps and overnight index swaps," said Anita Fung, director and Asia-Pacific head of fixed income and derivatives at HSBC in Hong Kong. "On the asset side the trend was toward yield enhancement products, making them callable, such as swaptions, caps and floaters," she added. Volatility was also apparent in the regional interest-rate market as rates plunged. "The massive easing in the U.S. was coupled with interim volatility, particularly in Hong Kong, Taiwan and Singapore," added Fung.

MFS Investments plans to increase its allocation to European government and corporate debt from 11% of its $2 billion portfolio to about 15%, or by some $80 million, after U.S. high-grade and high-yield paper rallies. Jim Swanson, Boston-based fixed-income strategist, says U.S. paper should rally in either February or March at which time he would sell positions and shift more assets to German, Italian, Finnish, Irish and U.K. government paper as well as European banks.

This chart, provided by Citibank/Salomon Smith Barney Inc., tracks bid-ask prices for par credit facilities that trade in the secondary market. It also tracks facility amounts, ratings, pricing and maturities.