One up, one down

IFR Central and Eastern Europe 2009
5 min read

Derivatives exchanges clocked up new records month after month during 2007, but in 2008 things changed, with a spike in volatility trumping counterparty fears as investors’ principal concern. But in CEE the picture was more mixed: the more established Budapest exchange saw volumes fall, while Warsaw maintained its growth. Yet volumes remain focused on very few contracts in a region crying out for more international investors. Owen Wild reports.

The overall volume for futures and options in 2008 showed a dramatic change from previous years. Volume growth globally had been close to 20% in 2006 and over 30% in 2007, with exchanges in developed and emerging markets both driving growth. Last year’s volatility disrupted this momentum and growth fell back to around 14% globally. Europe accounted for a 23.65% slice of this – up significantly year-on-year as Latin American volume collapsed.

During 2008 counterparty risk soared to the top of investors’ list of concerns. Indeed while the Counterparty Risk Index – which tracks dealer CDS – has eased from its peaks, and fears that another dealer might disappear have fallen back, the experience of Lehman Brothers has ensured that investors continue to worry about counterparty risk. They are therefore willing to give up bespoke OTC contracts for the safety of central clearing that comes with standardised exchange-based trading.

Volatility was also a huge factor in 2008. Although levels were stable in the first half of the year they began to soar as the year progressed. The combination of the rescue of AIG and then collapse of Lehman Brothers rocked markets. Equity volatility surged to never before seen levels and stayed there. Volatility rises as markets fall and drops as they rise. Markets tend to trend upwards with large downward corrections that are comparably short. As a result volatility patterns tend to be a series of spikes interspersed with benign periods. In the latter half of 2008 volatility rose to all-time highs and the oscillating pattern of the equity market sustained this high level for months.

It is therefore not too surprising that interest switched from futures to options, as investors decided not to commit to future purchases and sales, preferring the flexibility of an option. This change in attitude proved a blow for some emerging exchanges where options markets have not developed – such as Budapest.

Budapest is the 36th largest derivatives exchange globally. It had volume in 2008 of 13.4m contracts, yet this was a significant 29% drop on the previous year of 18.8m – though this reflected a drop in activity across all parts of the exchange. The split between cash and derivative markets actually remained stable, with derivatives accounting for 41% of activity. This contrasts with other exchanges which saw a change in their business mix, to cash or derivatives, but reflects the development stage of an exchange where activity is largely domestic and a high proportion is linked to equity. This ensures the same investors are present in both cash and derivative markets.

Activity on these markets is also dominated by a few contracts or stocks which skew patterns. On Budapest 96% of equity trading is accounted for by the four main stocks, so changes in behaviour on just one of these names can determine overall volume changes – OTP is 57.8% of the equity market volume alone.

Still falling

The downward trend has continued into 2009 with index and single-stock futures dramatically down – though currency futures activity has remained firmer. Turnover in single stock futures was 125,913 for January and February on Budapest – a total that falls just short of turnover in December 2008 alone. Index futures volume has fallen less, though turnover was just 172,548 in February against an average of over 0.2m through 2008.

While the turnover numbers have fallen further still this reflects a fall in trade size as transaction numbers have remained stable in recent months.

Wiener Boerse, the smallest of the three notable derivatives exchanges in CEEMEA, has also seen derivatives interest slide, making the Warsaw Stock Exchange the only CEEMEA member to make progress. The Polish exchange now ranks just behind Budapest, thanks to growth of 34.5% in 2008 to 12.6m contracts. This is again largely due to a focus on a few contracts, such as index options, and dominated by domestics.

The emerging market exchanges, which can see domestic investors make up 90% of volume, are still seen as challenging to access because of regulatory curiosities, yet the growth in these markets remains strong. As more investors gradually get comfortable with exchanges, currency risk and trading and settlement platforms, volume should return to growth. The issue of counterparty risk makes it likely OTC development will remain limited for the meantime.