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Hedge funds bucked the trend of decreasing investments in emerging markets, with new hedge funds springing up and existing ones raising more capital. However, it was not an easy year. "It was a year where focused risk management disciplines were most needed," said Steve Howell, cio at Basis Capital a Sydney-based hedge fund. "Those who are simply long-biased managers, in say equities, suffered from the turmoil of market dislocations."

The Japanese weather derivatives market put itself firmly on the map last year with a massive conference and a pick up in the number of deals. "This is the first year that there's been constant deal flow," said Hiroshi Yoshimine, global head and general manager of the derivatives and structured products division at the Bank of Tokyo-Mitsubishi in Tokyo. Yoshimine expounded that while the bank has been offering weather derivatives for two years, "[deals] weren't too common then," adding "this year the market has taken off." Toshihiko Aizawa, group leader of the product development group at the Tokio Marine and Fire Insurance Co. in Tokyo, believes the market is growing out of its infant stage. "It's become a real market now," he added, estimating the annual notional volume in Japan to be around JPY40 billion (USD321 million) for the year. "That's three to four times bigger than the previous year," said Aizawa.

In 2001 the swap curve started to stake a serious claim to becoming the U.S. fixed-income benchmark of the future and the Federal Reserve ensured there was volatility with eleven interest-rate cuts. The interest-rate cuts helped to spur growth in the derivatives market throughout the year, as strategists and marketers pumped out products to aid investors looking to capitalize on the cuts.

Singapore-based OUB Asset Management, which recently became the first portfolio manager in Asia to actively manage a synthetic collateralized debt obligation, is looking to manage additional structures this year. "We're still in the preliminary stages," noted an official at the firm, adding that several investment banks have approached OUB. He said it will chose which CDOs it manages and when based on its prediction for credit derivatives spreads widening and the robustness of the structure.

J.P. Morgan and Salomon Smith Barney are separately structuring synthetic collateralized debt obligations. The deals are unusual because they are referenced to high-yield debt whereas most synthetic CDOs are based on investment-grade assets. The CDOs, which were being pitch to end users last week, have yet to be finalized but range in size from USD300-500 million with maturities of five to seven years and are expected to hit the market in the next couple of months. Officials at J.P. Morgan and Salomon Smith Barney declined to comment.

Hanwha Chemical Corp., a global chemical manufacturer in Seoul with over KRW3.631 trillion (USD2.8 billion) in assets, entered a currency swap last month, converting a U.S. dollar loan into Korean won. The loan, a USD100 million six-month LIBOR facility, will be used toward the purchase of petrochemicals, said Y.K. Kang, manager of foreign exchange in Seoul. In the swap, Hanwha pays dollars and receives won at an exchange rate of KRW1,308.30. The maturity mirrors the life of the loan. Kang added that the firm is leaving the remaining 50% of its USD200 million loan portfolio unhedged to participate in potential won upside against the dollar.

As elsewhere, in the Asian fx derivatives market the previous 12 months could be summarized by two words: "low vol," and a concomitant increase in the use of plain-vanilla instruments, according to Louis Cucciniello, head of options at J.P. Morgan in Singapore. With vol lower across the board, vanilla options offered a strategy with a lower-than-usual cost to express directional views, he explained. And unlike structured derivatives, users of vanilla options did not cap their upside participation.

Buyside and sellside firms spent the beginning of the year arguing over what constitutes restructuring and whether it counts as a credit event (DW, 2/5, 3/19). But in May the International Swaps and Derivatives Association published a supplement to its 1999 definitions of credit derivatives that introduced modified restructuring. However, while U.S.-based institutions accepted it quickly and Asian firms followed soon after, European institutions have not adopted the new language. One market maker estimated only 40% of new contracts in Europe included modified restructuring.

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.