European institutional investors and banks were increasing their use of equity derivatives in the months leading up to the historic events of September and October 2008, but it remains unclear how much of this business ultimately will be affected by the crisis among global banks.
The European structured or securitized equity derivative products business remains heavily dependent upon the ability of private banks and some institutional clients to on-sell product to retail and high net-worth investors. The relatively lower levels of liquidity available in these products make counterparty risk a real concern for the accounts that purchase them and those concerns have taken on new urgency with the failure and near-failure of some of the worlds largest financial services providers.
According to the results of the 2008 Greenwich Associates European Equity Derivatives Research Study, the notional value of structured or securitized equity derivative products traded in Europe soared by two thirds to a projected $500 billion across the entire universe of 335 institutions and banks targeted in the Greenwich Associates research over the 12-month period ending in June 2008 . Over the same period, the share of European accounts using these products increased to 82% from 79%. European accounts were moving in exactly the opposite direction as their counterparts in North America, many of which stopped using structured equity products as the global liquidity crisis set in, says Greenwich Associates consultant Jay Bennett.
Among the most common uses for equity derivatives among European institutions are as an overlay to broaden equity investment strategies and as a means to express directional views on individual stocks, sectors, and markets. Almost half of European institutions say they use derivatives for one or both of these functions. More than one in four European accounts also say they employ complex portfolio strategies that include derivatives as core components.
More than 55% of banks principally purchase structured equity and securitized products with the intent to on-sell the instruments. Banks remain the most active users of these products, with over 85% employing them last year. Eighty-three percent of banks that use these products say they on-sell them, as compared to 60-65% of investment managers and mutual funds. Institutions that do on-sell typically move 85% of their structured equity products in this manner, and direct a rising 72% to retail or high net-worth customers.
The amount of commissions paid on equity options trades surged 55% to a projected $945 million in 2007-2008 across the entire universe of 335 European institutions and banks targeted in the Greenwich Associates research. Growth was strongest in the United Kingdom.
Despite the strong increase in trading activity across highly liquid flow products as a whole, usage of options actually decreased among European institutions from 2007 to 2008. After peaking at 82% in 2006-2007, the use of listed or listed look-alike options declined to less than three quarters of accounts from 20072008. The proportion of accounts using single-stock options fell to 58% from 80% and use of index options fell to 60% from 73%. Meanwhile, the use of futures increased slightly, to almost 80% of European institutions from less than three quarters.
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