Where’s the silver lining?

To some extent, the collapse of US energy company Enron at the end of last year set the tone for the financial markets in 2002. Bankers have had to negotiate the fallout from corporate America’s largest default, and in particular the highly publicised accounting malpractices exposed at Enron and a handful of other firms in the US and Europe.

These revelations have severely rattled investor confidence. Derivatives structures such as share option schemes have come under the microscope in the US, credit spreads on US and European corporates have soared, and equity markets across the globe have plummeted. While no Asian company was directly implicated in the accounting scandals, the region has not escaped the rout. In Hong Kong, the Hang Seng Index has fallen by more than 12% over the year, while Japan’s Nikkei 225 stock index has been hovering at 19-year lows for most of the fourth quarter. Consequently, banks across the region have been cutting staff and consolidating their operations.

Partly in response to falling stock markets and a related drop off in corporate finance transactions, a number of banks, such as Credit Suisse First Boston, JP Morgan Chase and Salomon Smith Barney, have integrated equity derivatives capabilities within their equity capital markets (ECM) divisions. The restructuring is aimed at opening up new avenues of business for both ECM and equity derivatives by enabling the combined group to offer a wider array of products to corporate treasuries. With some regulators around the region putting pressure on banks and corporates to slash the cross-shareholdings on their balance sheets, bankers hope that this operating structure will stand them in good stead in 2003 (see pages 14–15).

In South Korea, however, it’s been a difficult year for foreign and domestic banks alike. The surge in structured notes in the first half of the year – many of which linked to constant maturity Treasuries – went down a storm with local investors, eager for yield enhancement. But with few hedging alternatives available, banks turned to the swaps market to hedge the deals. As more and more banks streamed into the swaps market, all taking the same position, the swaps curve was forced below the government yield curve leaving a number of financial institutions with sizeable losses .

But it’s not all bad news. As our annual interbank poll shows, the Asian derivatives market continues to develop, with more products available in a growing number of local currencies. This year’s poll comprises 85 categories, up from last year’s 72. As liquidity in these derivatives products grows, end-users are increasingly able to make use of innovative structures to hedge their positions and reduce the cost of funding.