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UnionBanCal, the San Francisco-based holding company for Union Bank of California, is considering entering an interest-rate swap to convert a fixed-interest rate USD200 million bond offering it brought to the market last month into a synthetic floating-rate liability, according to K. Hamahashi, treasurer. He added that the swap would likely be a plain-vanilla deal with a five-year maturity to match the bond offering. "We look at the swap market on a continuing basis. This is something we've been considering as part of the entire bond offering process," Hamahashi said.

Whether it was making a first foray into weather derivatives, launching a hedge fund, issuing catastrophe bonds, or setting up a fund-of-funds the alternative investment sector skyrocketed in 2001. With the equity market in the gutter firms and wealthy individual investors began exploring other avenues for capturing high returns. "Investors are coming up against a challenging market that's having a massive impact on their portfolio construction. We've seen a sustained period of shrinking equity premiums that's had a real impact on traditional asset allocation. We realize that high-quality alternative investments can improve portfolio returns, while at the same time reduce overall volatility," said Bill Santos, managing director of Montgomery Asset Management, a San Francisco-based investment firm with more than USD7 billion in assets.

Investment banks entering the weather derivatives market gave the nascent industry a seal of approval just before Enron, one of its pioneers, filed for bankruptcy. Among the firms to enter were Barclays Capital (DW, 1/15), Dresdner Kleinwort Wasserstein (DW, 5/7), Credit Suisse First Boston, Deutsche Bank (DW, 5/20) and Italy's IntesaBci (DW, 7/16).

Commonwealth Investment Management, the fund management arm of Commonwealth Bank of Australia, is preparing to trade credit derivatives for the first time. It will trade single-name credit-default swaps in about six weeks. "We're gearing up for this," said Tony Adams, senior portfolio manager in credit investment at Commonwealth Investment Management in Sydney. Adams continued that it will trade credit default swaps on global names, primarily selling protection, for its AUD1.1 billion (USD567 million) Commonwealth Diversified Credit Fund. The asset manager has AUD30 billion under management.

The U.S. credit derivatives market was impacted by two of 2001's most unsettling global market events. The first was the bankruptcy of energy-giant Enron, which was closely followed by the collapse of Argentina's government and the specter of devaluation.

The European credit derivatives market experienced its first investment-grade defaults, a potentially damaging regulatory challenge and a change in its legal backdrop during an active 2001.

In an otherwise quiet week fx traders in Singapore last week reported strong demand from hedge funds buying short-dated euro calls/yen puts, which boosted volatility. "A few funds are creating a big effect," said an options trader at a European house in the Lion City, noting that their actions were magnified by the thin post-holiday markets.

The U.S. equity derivatives market was particularly hard hit in 2001 as initial public offerings and mergers and acquisitions slowed to a trickle. The lack of business translated into about a 30% decline from 2000 in the average notional size of trades and forced firms to look toward cutting costs. With the decline also came a focus on high-net-worth investors who were looking to hedge losses from the fall in underlying stock prices through innovative products, such as Banc of America's PEACS product, which allows investors saddled by the restrictions of insider trading rules to capitalize on stock sales in a volatile market. PEACS gave investors, such as those who sit on the board of directors at corporations, a chance to lock in a price of their shares and avoid downswings in the market, said Christopher Innes, managing director and global head of equity financial product sales at BofA in New York.

European pension funds ramped up their buying of long-dated swaptions and their activity had a profound influence on the euro swaps curve last year, leaving market professionals talking about similar concentrated buying and what impact it may have next year. The buying, especially from pension funds in Denmark, led to an increase in volatility not seen since the 1998 financial crisis, according to Meyrick Chapman, a derivatives strategist at UBS Warburg in London, who added the new levels may be here to stay.

Depressed equity markets fueled a surge in popularity for equity-linked hedge fund products and absolute return strategies, highlighting the year in synthetic equity developments. Capital guaranteed funds, some with lookback options, were also popular as investors turned bearish and world economies, particularly in the U.S., teetered toward recession.

Invesco Global, the European and Asian arm of Invesco Asset Management with USD56 billion under management, may launch its first long/short equity fund in the coming months, which would use exchange-traded and over-the-counter equity derivatives. "To raise new money in this environment you have to have something a little different, which is why we are looking at this now," said Angus Pottinger, product manager in London. The U.S. arm, with USD304 billion under management, currently runs long/short equity funds but this would be the first for Invesco Global, which mostly sells funds to U.K. residents in sterling-denominated accounts, Pottinger said. He declined further comment regarding how large the fund would be and what factors Invesco is considering.

HypoVereinsbank, Germany's second largest bank, is looking to complete its first synthetic collateralized debt obligation in Japan in the coming weeks, a deal that will be around USD500 million in size. Nick Hamilton, managing director of securitization and credit trading in Singapore, noted that his team in Tokyo will likely bring the deal to market in five weeks. The CDO, which was held over from last year, is currently being rated.