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ISDA PRESS REPORT, THURSDAY, SEPTEMBER 7, 2000
* Report Says Banks, Brokerages Need to Advance into Investment - The Korea Herald, 9/7/00 * OCC Official: Still Hopeful For Derivatives Reform - Capital Markets Report, 9/6/00 * UK ROAD TO EURO: Little Evidence of Euro-Creep in UK - Dow Jones International News, 9/7/00 * Banks' Trading Revenue Remains High, Quarterly OCC Derivatives Report Shows - BNA, 9/7/00 The Korea Herald, 9/7/00 Report Says Banks, Brokerages Need to Advance into Investment For the survival of the domestic financial industry in global competition, banks and securities companies need to be pushed to advance into investment banking, the Korea Securities Research Institute asserted yesterday. In a seminar on stock market development, the institute presented a paper calling for expanded participation in investment banking by domestic financial institutions. "The global financial industry is heading for a single market as evidenced by the growing synchronization of financial markets around the world," the report said. "Since the global financial industry is increasingly reshaped by mergers and acquisitions and business crossovers, domestic financial institutions should pursue investment banking." To promote investment banking in Korea, the institute said measures should be taken to build reliable databases of economic and financial statistics, foster experts, encourage brokerages to develop their underwriting capabilities, expand the concept of securities and encourage business crossovers among financial institutions. As promising areas of investment banking, the institute cited asset management, mergers and acquisitions, asset assessment, trading of over-the-counter products and derivatives, and securities designing. According to the institute, the global financial market is experiencing a transition from direct funding through banks to direct funding through stock exchanges. This sea change is demolishing the distinction between banks and securities firms. Furthermore, it said, capital liberalization in a growing number of countries is accelerating the integration of national capital markets into a single global market. "The pursuit of large size and business crossovers will intensify in the future. At the same time, progress in financial engineering and information technology will give rise to more complicated financial products, which will further liven up indirect investment instruments," it said. The institute said foreign financial institutions' inroads into the domestic market would increase, helping domestic institutions improve their business practices and financial technology. Capital Markets Report, 9/6/00 OCC Official: Still Hopeful For Derivatives Reform By Jonathan Nicholson WASHINGTON -(Dow Jones)- A top banking watchdog on Wednesday held out hope that laws dealing with derivatives transactions and bankruptcies may yet be updated this year. "If nothing happened, it would not be disastrous. There's not a lot of time left on the calendar," said Mike Brosnan, deputy comptroller for risk evaluation for the Office of the Comptroller of the Currency. "It would certainly be a better world if the bankruptcy and insolvency provisions were finalized. There's a chance that could happen," he said. Brosnan spoke to reporters during the agency's quarterly briefing on bank derivatives trading revenues. The second session of the 106th Congress is expected to adjourn by early October as lawmakers make their way home for the fall campaign. Brosnan said he hoped they could get to the provisions in a pending bankruptcy reform bill dealing with derivatives contracts. The White House and Congressional Republicans have been bogged down in negotiations over bankruptcy for some time now. The issues of contention, however, have revolved around consumer protection. Brosnan said he hoped the comparatively non-controversial sections regarding derivatives could be split from the bill and enacted separately if the bankruptcy bill fails to show progress. "It is my hope that that would occur and I think it would make for a safer and sounder banking system," Brosnan said. More sweeping reform, in the shape of a reauthorization and updating of the Commodities Exchange Act, is also pending in Congress. The CEA includes the structural framework for derivatives trading and regulation in the U.S. and modernizing it has been a priority for some years among regulators and trade groups. However, differing versions of CEA modernization have been approved by three committees in the U.S. House. Such divergent approaches are seen by many as limiting the chances for passage. "To the extent you could get one or both of those finalized in an agreeable format, it would add certainty to U.S. banks," Brosnan said. By increasing the legal certainty about the enforceability of derivatives contracts, it would lower costs and keep business from moving overseas, he said. Dow Jones International News, 9/7/00 UK ROAD TO EURO: Little Evidence of Euro-Creep in UK By David Cottle LONDON -(Dow Jones)- When high-profile industrial giants Toyota and Unilever asked U.K. suppliers to price their goods in euros, many thought more multinationals in the U.K. would follow suit, possibly making the euro the effective business currency of the U.K. irrespective of a decision to join. But so-called 'euro-creep', where the euro becomes the de facto currency for British companies despite the U.K. retaining the pound, has so far failed to materialize. U.K.-based businesses are still overwhelmingly loyal to sterling despite big fluctuations against the euro. "I think there is disappointment in official, pro-Europe circles that there hasn't been as much 'euro-creep' as hoped for," said Stephen Lewis, chief economist at Monument Derivatives in London. With Britain still undecided over whether it should adopt the euro, many in the pro-euro lobby say the commercial reality faced by many companies dealing with other European countries will mean they will end up having to use the single currency, like it or not. The issue gathered extra intensity recently when the British press highlighted the issue. Euro-creep Overstated But many now say 'euro-creep' has been overstated. "The fact is that euro-creep is hardly a factor at the moment," said David Page, U.K. economist at Investec Research. What is more, some analysts say that the euro has been almost as invisible in many euro-zone countries, where local currencies continue to hold sway, and will remain so at least until euro notes and coins come into circulation in 2002. There is an obvious temptation for companies with large operations in the U.K. and significant sales in Europe to ask U.K. suppliers to invoice in euros. This way they pass on the exchange risk down the supply chain. "Most of Toyota's U.K. production goes to Europe," said an analyst at consultants Business Strategies, "so they'll lose significantly in terms of the exchange rate and its volatility should their suppliers price in sterling." But Business Strategies reckon that these companies are reacting to a strong pound rather than displaying an undying loyalty for the single currency and that the weakness of the euro is a factor in its unpopularity as a trading currency. Weak Euro Hobbles Acceptance Others share this view. "With the euro at current levels it would be odd to see a big push towards it's use by European businesses," said Klaus Baader, senior international economist at Lehman Brothers in London. Of the companies that are using the euro in the U.K., Toyota says it will only demand euro pricing from some of its new supply contracts. "We have only asked a few of our new suppliers to tender in euros, and we have no plans at all to extend that base," said Richard Ayres, a spokesman for Toyota in the U.K. Unilever, meanwhile, has invited all its British contractors to tender in euros, but a spokesman for the company said it wasn't compulsory for them to do so, nor were there any plans to make it so. "We now obviously produce all our (financial) reports in euros and this is just an extension of that," he added. BNA, 9/7/00 Banks' Trading Revenue Remains High, Quarterly OCC Derivatives Report Shows By Adam Wasch Although trading revenue was down from the record $3.84 billion recorded in the first quarter of 2000, U.S. commercial banks earned $3.03 billion from trading activities in the three months ending June 30, the Office of the Comptroller of the Currency reported Sept. 6. The second quarter of 2000 represented only the third time the banking industry has earned more than $3 billion from trading activities in a single quarter. The first time it happened was in the first quarter of 1999, when commercial banks earned $3.6 billion from trading, according to the OCC, which released its quarterly Bank Derivatives Report. It has been six and a half years since the seven banks most active in trading have lost revenue from trading. Trading revenue is earned from cash instruments and off-balance sheet derivative instruments. A derivative is a financial instrument with a value based on the performance of an underlying asset, interest rate, foreign exchange rate, or other indexes. The OCC's quarterly report is based on quarterly call report information provided by domestic commercial banks. More Banks Using Derivatives OCC also reported that the number of commercial banks holding derivatives increased by 27 to 416. The notional amount of derivatives reported by commercial banks grew 4.5 percent to a record high $39.3 trillion in the second quarter. Most derivatives trading activity (96 percent), the OCC explained, is used by banks in their capacity as a dealer to service bank customers. The remainder is used to manage their own interest rate and other financial risk positions. "Contract volumes showed strong growth as bank customers managed risk positions in an environment characterized by rising interest rates and volatile and more uncertain market positions," said Mike Brosnan, OCC Deputy Comptroller for Risk Evaluation, told reporters at a press briefing. The average credit exposure from derivatives at the top seven trading banks fell to 247 percent of risk-based capital, OCC said, although Brosnan still called this a "huge" percentage. Credit exposure has declined since reaching a record high of 324 percent of risk-based capital in the fourth quarter of 1998. "There were no losses to speak of in the second quarter [of 2000]," Brosnan said. "The absence of past-dues and charge-offs [produced] a credit quality of over-the-counter derivatives that is noticeably better" than that seen in most commercial and industrial loans portfolios, he said. Most banks use derivatives to hedge credit risk, Brosnan said. The current economic climate, with its relatively large global swings in interest rates, gives banks added incentive to use derivatives, he said. Even so, less than 5 percent of banks currently use derivatives. But those that do are heavily scrutinized because of the highly sophisticated nature of derivatives and their potential to cost banks billions if deals go awry. "We watch banks' derivative activity to a disproportionate degree," Brosnan said. Derivative Bills Pending in Congress Three separate but similar bills are pending in Congress that would offer more predictability for derivatives market participants if their transaction counterparties fail. The bipartisan provisions, which the OCC supports, provide derivatives greater legal definition. The relevant language appears in pending bankruptcy reform legislation, legislation to reform the Commodities Exchange Act, and in a stand-alone bill (H.R. 1161) introduced by House Banking Committee Chairman James A. Leach (R-Iowa) and passed by the banking committee July 27. Such legislation would "add certainty" to the U.S. derivatives market, Brosnan said, and prevent derivatives trading activity from migrating to other countries that better legally define derivatives. "If nothing happens [in Congress], it would not be a disaster, but I hope it would occur," he said. Report Confirms Trends The notional volume of foreign exchange derivatives leveled off in the second quarter at $6.5 trillion. Continuing a trend, interest rate derivatives rose to a record $31.4 trillion. Since 1997, when banks first began reporting data on credit derivatives, the notional volume of these contracts has increased from $55 billion to $362 billion during the most recent quarter, according to OCC. Also, there has been a "pronounced and continued shift" in the kind of derivatives contracts banks use. Brosnan noted that as the volume of swap contracts has nearly doubled to $21 trillion since the second half of 1998, the volume of futures and forwards ($10.3 trillion), and options ($7.7 trillion) has all but leveled off during the same period. Brosnan said that this was due primarily to bank customers' preference for over-the-counter derivatives contracts such as swaps, which can be tailored to meet a customer's specific risk management needs. Other trends include the increasing popularity of one-to-five year equity contracts, which rose 27 percent in notional amounts. Equity contracts of less than a year have also become more popular, OCC said. The OCC's latest quarterly report is available on the agency's Web site at http://www.occ.treas.gov/ftp/deriv/dq200.pdf. End of ISDA Press Report for Thursday, September 7, 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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