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ISDA PRESS REPORT - MONDAY, NOVEMBER 27, 2000
* New Derivative Squeezes Power Out Of Bottlenecks * Derivatives Trade Darts Up In November * A Treasury Management ASP for FASB and Beyond * The Slow Death Of The FX Salesman New Derivative Squeezes Power Out Of Bottlenecks Dow Jones International News - November 27, 2000 By Michael Young As the deregulated Nordic power market plugs into new regions, an electrical short-circuit has set off trading in a new derivative. Price differences that arise from bottlenecks in the Nordic region's power grid capacity has led the local electricity bourse, Nordpool, to launch a new category of derivative - Contracts for Difference - with hedgers and speculators keen to give it a go. "I think they could easily make some headway into the market, and we intend to trade them, that's for certain," said Allan Toft Hansen, power trader at Elsam, one of the largest Danish power producers. A large proportion of electricity in the Nordic area is traded on the Nordpool exchange, the world's first international commodity exchange for electrical power. The bourse matches power producers and power wholesalers, setting Nordic-wide prices for each hour of the following 24-hour day. Also, power derivatives such as futures and options are traded, and with the contracts for difference, a new, third type of financial instrument is to be bought and sold. Demand for this new type of derivative contract came from price anomalies between the Nordic electricity regions, price differences that are the result of bottlenecks in the power grid's capacity. Nordpool started the new contracts on Nov. 17, and in the first week a total of 374 gigawatts hours were traded. "This was bigger turnover than we expected," said Hartvig Munthe Kaas, head of corporate communications at Nordpool. He added that he was optimistic about turnover developing in coming months, although he declined to put a figure on it. "It is a tool for alleviating a situation where you have different area prices for the same product," Kaas added. Capacity limits on the power lines may cause, for example, a predominantly coal-powered western Denmark region to be priced higher than a region in Norway, where full reservoirs for hydroelectric plants allow super-cheap electricity to stream out of the turbines. As a result, producers and distributors face uncertainty as to whether their region will be served with the lowest price. The contracts for difference allow market players to hedge against, or take on, the risk of these regional price differences. Paradoxically, the need for a market in contracts for difference increased with the success of the Nordpool pricing system, which was originally designed to ensure more homogeneous pricing for different regions: As electricity markets integrate through advanced market systems, the grid capacity is overloaded between coal-powered producers with one set of prices, and hydro-powered producers with another. "The contracts will become more and more usual, the more that hydro-generated power integrates with coal-generated power," says Flemming Loekke, who heads power trading at Danish company Elektra Energihandel. And with moves to integrate Nordic and German electricity planned, more exchange trading in contracts for difference will plug the price gaps between coal and hydro-power, he says. With the Scandinavian power trading exchanges being increasingly integrated with other exchanges in northern Europe, demand for an instrument to avoid, or take on, the risk of price anomalies through the bourse may increase. "If spot prices differ on the same market, then indeed there is room for more use of this instrument," said Nordpool's Kaas. But some market dealers are doubtful about the prospects for a derivative that allows some producers with inside information on grid capacity to make gains, while those less fortunate bear the risk. "I am skeptical. Some producers have access to privileged information, and this could give them market power," said Jon Ove Heen, a trader at the Norwegian power company, Interkraft. Derivatives Trade Darts Up In November Our Markets Bureau - November 25, 2000 Total volumes in the derivatives segment of the Bombay Stock Exchange (BSE) witnessed an increase of 30.67 per cent till November 23 to Rs 170.99 crore from 6,875 contracts, compared with Rs 130.85 crore from 5,554 contracts in October. The National Stock Exchange (NSE) also saw a jump in the trading volume in its derivatives segment at Rs 161.99 crore from 6,507 contracts till November 23 against Rs 152.85 crore from 6,388 contracts in October. Manoj Vaish, deputy executive director, BSE, said, "We expect the derivatives segment to witness a daily trading volume of Rs 100 crore by March 2001." Derivatives trading started in June with a modest volume of Rs 35.22 crore from 1,190 contracts on the BSE and Rs 35.25 crore from 1,191 contracts on the NSE. In July, on the BSE the volume moved up to Rs 88.08 crore (3,109 contracts). On the NSE, the volume increased to Rs 108.40 crore (3,583 contracts). Since then, the trading volume in the segment has been gradually improving, despite the fact that most institutional players are not much active in the segment. Analysts point out that another major hurdle in the derivatives sector is the lack of a pricing mechanism for contracts. Normally, pricing of derivatives is dependent on the interest rates in the country and there are arbitrage opportunities across the debt, derivatives and equity markets. In the absence of a debt market, no proper pricing mechanism has been established yet in the country. "Arbitrage opportunities are essential for the healthy development of the capital market and today we only have speculators in this segment as hedging is virtually absent owing to the absence of index funds. Also, arbitrage cannot be done because there is no debt market in the country. So, only speculation can be done and no market can be developed with mere speculators. Hence, institutional presence in the derivatives market will take time," analysts said. Meanwhile, the BSE has received 10 new applications for limited trading membership in the derivatives segment. This is in addition to the 150 regular members. A Treasury Management ASP for FASB and Beyond Derivatives Strategy - October 2000 By Robert Hunter The implementation date for Financial Accounting Standard 133 was pushed back so many times that corporate treasurers and accountants alike began hoping the elephant in the living room would just go away. But now that it's finally a reality, they're scrambling to apply the complex rules to flesh and blood accounting reports. In spite of the long delays, a surprisingly small number of vendors offer products that can even charitably be considered FAS 133 compliant. All of which is good news for Reval.com, an application service provider trying to bridge the chasm in FAS 133compliant treasury management systems. Reval bills itself as the only Internet-based treasury management system that addresses FAS 133 in any kind of comprehensive way. "I think it's a misnomer for any software company, including Reval, to say that it's FAS 133 compliant," says Jiro Okochi, CEO and co-founder of Reval. "The company, not the vendor, needs to be compliant and it's our job to simplify and clarify this task. Some vendors may be misleading the end user into thinking that purchasing their software automatically solves all of the company's FAS 133/138 issues- and that is wrong." The company's ultimate goal is to help corporate treasurers at Fortune 1000 and middle-market companies centralize their disparate patchwork of treasury management systems, and avoid the manually intensive processing associated with these trades by warehousing financial data on the Internet. At the moment, high-functionality treasury systems are quite pricey, while cheaper systems cover only the generic vanilla structures. Reval hopes to fill this gap by offering an affordable web-based solution that covers a broad range of asset classes including derivatives. Of course, product coverage isn't the only problem facing treasury systems trying to deal with 133. Even if a package accommodated every financial product known to man, the Big Five accounting firms each have their own interpretation of the standard and these views may contradict each other. Moreover, since the Financial Accounting Standards Board is still dealing with Derivatives Implementation Group issues, FAS 133 accounting remains a moving target. By offering an Internet-based solution instead of a standalone system, Reval can adapt to evolutionary changes as decisions are made. Simple web-based systems, with their common interfaces and unlimited scalability, are dearly the wave of the future, if not the present. But true derivatives functionality is still rare in treasury ASPs, and therein lies Reval's opportunity. "For- the bigger companies," says Okochi, "we're not going to be immediately accepted as a stand alone systems alternative. We're going to have to prove ourselves to them. We'll do this by starting with a derivatives and FAS 133/138 specialization. As people gain awareness and comfort with Reval's accomplishments in delivering these sophisticated tasks via an ASP model, they'll subscribe to more of our treasury functions across the board." Under the new standards, all derivatives are marked-to-market on the balance sheet. The main challenge for treasurers is to find an underlying hedged item that can also be marked-to-market into earnings to offset the derivative's change in market value. Any changes in value that don't match are deemed ineffective, and are reflected in a company's earnings. As a rule of thumb, no one wants variability in derivatives positions to affect earnings. As an alternative, however, a company can try to prove that a derivative hedges a variable cash flow, in which case it can be recorded as other comprehensive income ("OCI") directly on the balance sheet, with no earnings impact. What does this mean for treasury systems? In the good old days, a company that issued debt could rely on a simple system that monitored the debt portfolio with an entirely separate derivatives accounting function handling the accompanying swap. Some bigger companies, of course, boasted systems that could monitor price and risk-manage the derivative portfolio, but such functionality was rare. Now, because hedges must be priced and tied to the underlying hedged items at an inception, integrated derivatives accounting is more critical than ever. To address this, Reval plans to provide full mark-to-market services, including pricing models and independent third-party market data. "You can have the best and brightest stars write all the C++ algorithms you want," says Okochi, "but unless you have good market data going into the models, you won't generate a very good price." Reval will also match hedges with underlying hedged items and track them throughout their lives, as FAS 133 requires. The Slow Death Of The FX Salesman Derivatives Strategy - October 2000 By Barclay T. Leib. When new technology first started eating up jobs at foreign exchange voice brokers like Garban Intercapital, and Cantor Fitzgerald, it didn't take long for foreign exchange salespeople at dealer firms to figure out that they were next on the menu. The foreign exchange world - a huge, geographically disperse but ultimately simple two-way market that depends mostly on the speed of execution-was a natural to go electronic. And today, electronic systems - most notably the Electronic Broking Services platform - dominate the interbank foreign exchange markets. EBS itself now captures more than 90 percent of the daily inter bank trading volume. Traditional voice brokers in cash are all but dead. Add the Internet age, and the pressure only gets worse. A dizzying array of new foreign exchange trading platforms, such as FXall.com, Atriax.com, Currenex and CFOWeb.com, promise that they'll soon allow clients to do everything from research to execution on the web, leaving little room for the humans to work. Meanwhile, bid/offer spreads are shrinking quicker than a waif model for Calvin Klein. The official line from the banks, even as they go electronic, is that there's still an important role for salespeople to play. Good salespeople are still essential to cement client dealing relationships, they say. What salespeople might lose in spread revenue, moreover, can be made up by revenue from greater volume and sales of structured products. Banks even say that electronic trading is a good thing for the salesfolks. The more sales and trades done electronically, the more time salespeople have to analyze markets and cook up profitable, sophisticated hedging strategies. It also means they have more time to prospect for new clients, which should be great news for the salespeople. Who wants to be stuck in the office with five telephones on two ears when you could be out wining and dining? But does anyone really believe that? Do the banks have a truly cogent game plan to sort all this out? At the very least, what new qualities must salespeople now possess to hold down a job? Given that foreign exchange is ahead of other capital markets in its use of electronic price delivery, the answer to these questions could set the tone for the future of all Wall Street salespeople. So listen carefully. I CAN SEE CLEARLY NOW First, it is important to put things in perspective. What exactly are the facts for foreign sales staffs? Fact one: The recent spate of bank mega-mergers means that fewer banks are trading foreign exchange. Moreover, big banks seem to be getting bigger and more powerful in this area, while the small ones are slowly falling by the wayside. Banks like KBC Deutscheland, Daiwa and Nikko have all dosed their spot foreign exchange trading in London; SGCowen New York has laid off part of its corporate sales force; and DG Bank recently shut down foreign exchange trading in New York. At the same time, after aggressively re:: cruising new salespeople in 1999, Deutsche Bank has stolen market share even from the likes of UBS Warburg and JP Morgan. The latter institutions reported lower foreign ex: change volumes and profitability during the year, and specifically cited foreign exchange as an overall drag on their corporate profitability. JPMorgan will soon be folded into Chase; and a nascent foreign exchange effort at Donaldson Lufkin & Jenrette will soon be absorbed into Credit Suisse First Boston. According to head-hunters, resumes from both Morgan and DLJ have already hit the street. In short, the number of bank players is down, and bank foreign exchange volumes have been static to slightly lower in the year 2000. Fact two: Since the introduction of the euro last year, there are fewer currencies to trade. In the words of Adam Sorab, a former London-based foreign exchange salesman at CSFB, "The Rubix cube of currency risk management has been reduced to a much simpler match-the-shape type puzzle. With no more lira, peseta or other fringe-European currencies to worry about, risk management has generally become simpler." Without fringe currencies to worry about and trade, many previously spreadable opportunities for the banks have also flown out the window. Fact three: There are fewer customers. Large macro hedge fund managers and commercial speculators have, for a variety of reasons, stopped trading the way they used to. This may have more to do with losses in other macro bets gone awry - in equity markets and elsewhere - as opposed to problems within the foreign exchange market itself. But for whatever reason, it is making the business a tougher one for salespeople. According to one London-based salesperson, "The foreign exchange market used to have three prongs to it: the hedge funds, the commercial speculative community and the commercial hedging community. Now, with the demise of Tiger Management and the downsizing of George Soros' Quantum Fund, some of the biggest clients have simply disappeared. Speculative commercial accounts such as French corporates Batif, Aerospatiale and Thompson have also largely stopped trading in the aggressive style of yesteryear." This still leaves the commercial hedgers with simple trade-flow repatriation, but foreign exchange in general is now a much lonelier and thinner market. "The only recent players with any step-up in activity are the banks doing one-off hedging for large M&A activities and global equity managers rebalancing their portfolios and currency exposures," says this salesman. "If you don't see those flows, you're dead. Almost everyone else is gone." He's particularly incensed because the year 2000 has brought some good-sized moves in the market. "We've gone from 117 to 85 in l the euro. Deutsche mark-yen for us old-timers has fallen off the charts to 46.70! But nobody cares. The hedge fund community is not around. It's mind-boggling." Fact four: Salary and bonus levels are stagnant. "Gone are the days of the mega-deal with big guaranteed bonuses," says Elaine de Flores, president of the recruiting firm de Flores International in Stamford, Conn. "Some guarantees are still given, but it's not like the old days. You really have to produce - put your money where your mouth is - to get paid." De Flores' thoughts are echoed by foreign exchange recruiting specialist Kenny Blonder, senior vice president of Integrated Management Resources in Tempe, Ariz. "Salary levels have been flat," he says. "The highest paid salesperson might make $150,000 tops as a base salary these days." COUNT YOUR BLESSINGS So what's the good news? Well, salespeople may be surviving better than some traders are. Blonder says that in the last two years, he's placed strategists, economists, quantitative people and a few salespeople, but he hasn't been able to place a single currency trader during that time. "E-commerce and the EBS may be even tougher on the traders than the salespeople," says Blonder. "No one calls out to do spot business anymore. Volume is just done on the machine. With the new platforms, one guy can watch more currencies at the same time. You don't need hoards of trading staff." Having said that, there are still two factors keeping demand for salespeople firm for now. First, according to de Flores, banks still want a few "rainmakers" who bring a book of clients with them when changing firms. "All recruiters are looking for the same person," she says. "He or she must have a loyal customer base that is transferable and must be well-versed in derivatives and other markets as well as foreign exchange. The interview process has also grown lengthier and fussier. Banks want to see more people. So while there's still a demand, it's not easy to dose a deal." The second factor is, ironically, excessive and premature pessimism over the future of the business. A New York foreign exchange salesperson notes that "Because the death bells of this business were rung so loudly and so early, no fresh new blood has come into foreign exchange for three or four years, maybe longer." Unfortunately, he does not think this will help over the long term. "I don't think we're all going to die, but I think we will be in a reduced-salary, advisory role," he says. "I certainly can't promise to bring anyone a given amount of turnover and profitability anymore. The business no longer works that way." LOOKING FOR THE PATH OUT Given all of the above, what is the average foreign exchange salesperson or trader supposed to do? The threadbare spreads are prompting a lot of people to contemplate switching careers. "Up to two years ago, I could make $6 million in spread revenue for my institution in a good year," says one salesman at a U.K.-based bank. "This year, I'll be lucky to make $2 million. That's still enough to keep my job, but I'm working harder now to take home far less money. If something better came along, I'd take it." De Flores confirms that this is the overall attitude. "I can't tell you how often I get a phone call from some foreign exchange person asking, 'What do I do? Where do I go? How do I reinvent myself?"' she says. "Women in particular are getting out of the business in droves - taking the attitude that it is not worth it to come in day after day chasing the same small group of customers. I don't mean to sound sexist at all, but they are leaving the industry either to go home and take care of the kids or do something completely different - sometimes in business-to-business commerce. There's really a dearth of women in the industry now. Men, unfortunately, don't quite have that luxury of just packing it in. More often, they are forced to at least try sticking it out." De Flores specifically says that many traders, quart-types and structurers inquire about the buy- or equity-side of the business. "They'd be there in a heartbeat if I had more of these positions," says de Flores. But while business may be getting more difficult at the margin, people are still holding onto their jobs for now, mainly because no* may be the worst time to jump ship to another firm. "As always, it's easier to fill a position going up the chain than down," says Blonder. "People are always happy to step up to a Chase, Citi or Goldman, as opposed to moving down to a smaller bank. But those making the step up know that if they don't perform once they get there, they risk not having a seat anywhere at all." WHERE TO GO? To survive within the industry itself, a foreign exchange salesperson today needs to know more than how to spread spot and forward foreign exchange trades. What's required is a strategic ability to transact orders in a variety of markets, and to solve problems for clients using derivatives. "Three-way option deals are still going to require the human touch for quite awhile to come," says one recruiter who is still bullish on the prospects for quality people within foreign currency sales. Salespeople not capable of reinventing themselves also might find a niche selling the very technology that threatens them. "We may end up with two distinct groups of sales people," muses Craig Puffenberger, managing director in charge of foreign exchange trading at CSFB. "One handling complex trades and advisory functions, while the other just services the portal." In the meantime, to those thinking of leaving the business altogether, Ian Dow, president of Dow Consultants in New York, advises, "You're going to have to reinvent yourself a bit, re-train, maybe take a pay cut." According to Blonder, "There are jobs in e-commerce, tech companies and foreign exchange trading software vendors, and I have made a few placements there. The only problem is that while many of these companies pay a competitive salary, they usually don't come dose on a bonus basis." Notwithstanding that caveat, electronic trading platform Currenex has recently lured several first class veteran sales people to its offices, hiring both Keith Hill from JP Morgan's London office and Kendra Wisler, formerly of UBS Warburg. Perhaps stock options did the trick. Others have found positions on the buy-side. Laura Munisteri, a veteran foreign exchange trader, options specialist and salesperson, formerly of Deutsche Bank's Frankfurt office, joined the United Nations Common Fund in 1997 before moving in 1998 to join the global corporate treasury area at Philips AG. Others have headed into consulting. One individual with a strong foreign exchange and treasury background decided in 1997 that the time had come to hang up his sell-side boots. He started out as a senior consultant at a Big Five accounting firm and says he's never regretted the switch. "To make any real money as a consultant, you have to become a partner," he says. "And even though I did not have the credentials to come in at that level back then, I'm much closer to that objective now. I've taken my capital-markets expertise and been able to apply it to a whole slew of new businesses - these days largely in the dot-coin world." Others have gone into the regulatory agencies. Ernest Eckersdorf, who spent most of a seven-year career at Citibank running corporate foreign exchange sales, and then played a similar role at Societe Generale for eight years, now acts as a supervising risk management specialist for the New York State Banking Department. "I get to see a wide cross-section of institutions from the top down," he says. "It is actually quite enlightening, and professionally it's extremely satisfying. There is simply no comparison between what I do now and the single low-margin product that foreign exchange has become." Meanwhile, Sorab, formerly of Credit Suisse foreign exchange sales, leapt at an opportunity in 1996 (when Credit Suisse and CS First Boston merged their foreign exchange efforts) to shift his focus. He moved into the hedge fund marketing and investor relations group of CSFB's leveraged funds group. Four years later, he is happy he did that. Sorab is soon to become a director of European sales at Deutsche Asset Management's absolute returns group in London. "I still have a great many friends in foreign exchange, and many of them are looking to get out - if they can," he says. Lastly, we find Christina Engelchor, formerly a 10-year ABN Amro foreign exchange salesperson, now happily at home in Nagele, The Netherlands, with her four-year old son, Cees. "I enjoyed what I was doing for a long time," says Engelchor. "But then the technology started getting better and the clients more astute. Foreign exchange became too competitive. Money-making opportunities were declining, just as my personal priorities were changing. Being a woman working in Europe within a male-oriented business also wasn't always particularly easy. Sometimes I felt like I was the only female member of a European football team." So there you have it. The impending death of the foreign exchange salesman was predicted by some as early as 1996, and has been acknowledged by more and more since then. Some banking models are less threatening (see "Wells Fargo Takes a Novel Approach," Page 7), and a good salesperson who can also act as a strategist and derivatives expert will likely survive. But the very nature of e-commerce puts the pressure on the bottom line - and as that pressure builds, look for the sales community to change almost as much as the voice braking community has. While banks are loathe to admit it, shedding expensive foreign exchange sales staff and excess traders may be the only way they can survive and profit as e-trading truly begins to burgeon. "Everyone has access to EBS now, even if they are not supposed to," says a European salesman. "The banks are themselves a major disservice by providing such transparency. If this continues, within two years all flow transaction will go from a company's corporate headquarters directly into an electronic system, bypassing salesman. The only exception will be very large-sized trades and structured options-oriented trading." "It's obvious - we're not necessary anymore," agrees a Chicago-based salesperson as cheerily as she can. End of ISDA Press Report for Monday, November 27, 2000. THE ISDA PRESS REPORT IS PREPARED FOR THE LIMITED USE OF ISDA STAFF, ISDA'S BOARD OF DIRECTORS AND SPECIFIED CONSULTANTS TO ISDA. THIS PRESS REPORT IS NOT FOR DISTRIBUTION (EITHER WITHIN OR WITHOUT AN ORGANIZATION), AND ISDA IS NOT RESPONSIBLE FOR ANY USE TO WHICH THESE MATERIALS MAY BE PUT.
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