Bank resources are directed to cash-rich Russia and the Middle East rather than the CEE countries that provide little derivative opportunities. But while the institutional market remains slight, retail interest is driving demand for structured products, at a time when they are a hard sell across Europe.
Emerging markets have been a boon for bankers across asset classes since 2000. International investors have ever more desire for exposure to these markets, while their domestic investor bases also grow. In EMEA, Russia and the Middle East have seen the most attention in the past three years – boosting the derivatives markets there, as investors look to hedge or gain exposure, especially for equity as part of M&A transactions. But Central and Eastern Europe has not provided a similar level of activity.
"The gulf region has seen both asset growth and investor growth, and this has led to it becoming one of the largest investors in structured products globally, though many have lost money through these in recent months," said one equity derivatives banker in London. "Russia is a different story with no distributed wealth, so clients are concentrated hedge funds or corporates with a portfolio to protect of mostly domestic assets. CEE doesn't have the wealth of other emerging markets in EMEA, and has yet to develop significant interest in advanced products."
Regulatory regimes in CEE have stifled opportunities for equity derivatives. In Poland, pension funds – the largest institutional investor group by a large margin – are subject to restrictions on owning foreign stock, largely limiting them to buying Warsaw-listed assets. They have also been subject to penalties for underperformance from the regulator, which did not encourage hedging activity to protect value, but rather a herding mentality, with funds replicating strategies and portfolio construction.
Yet exchange-based products have started to emerge, particularly futures in Poland and Hungary, the largest markets in Europe at multiple times the size of their competitors across EMEA. The volumes in Poland and Hungary have seen the exchanges establish themselves as important regional hubs.
In 2007 the Warsaw Stock Exchange saw contract volume reach 9.4m and in Hungary volume totalled 3.95m, ranking the exchanges as the fifth and seventh largest in Europe respectively. The increase in volume represented a 40% increase for the Warsaw exchange, yet volume for the region still remains largely in the hands of Eurex and NYSE Euronext, which had volumes of over 400m and 90m each. Polish volume also comes from one contract with WIG20 futures covering 94% of all trading, making this the eighth most popular index future contract in Europe.
Retail investors are, however, driving the growth in structured products. The market is still young with dedicated teams built in the last three to five years, but it offers good potential; no retooling of products is required to suit local investors.
"The core CEE markets are different to the rest of Europe, but on the retail side do not have different characteristics as a region. Hungary is as different to France as Italy is. The dynamics of each market are a result of local regulation, history and market development," said Jean-Eric Pacini, head of structured products at BNP Paribas in London. "When first focusing on the CEE market in 2005 there was initially a desire from investors for exposure to only local underlyings, but now interest is more global and at least regional, while the type of products has always been broad and reflects those offered around Europe."
While the structured products markets in the region – mainly Hungary, Poland and the Czech Republic – are building from a low base, growth is around three times the levels of other countries in Europe. At a time when structured product sales have become difficult the prospects of a market that is still catching-up become more important.
Retail investors dominate structured products because of the historically tight grip regulators have held over institutions. But as institutions grow, this is relaxing, and a market for tailored institutional structured products has opened up. BNP Paribas provides pension funds with direct exposure to hedge funds through an indirect wrapper, including capital protection – the structure that allowed it to meet regulatory approval. Considering many funds are now over-invested in their home markets, the desire to diversify should suit bank structured product offerings.
The desire for diversification is reflected in the success of cross-asset class products that allocate based on triggers. Polish accounts have created significant demand for products that provide dynamically-weighted exposure to real estate, interest rates, foreign exchange, commodities and equities. This is a broader spread of asset classes than normally seen in one product in Europe.