Derivatives market to 'explode'

25 September 2006

The derivatives market grew globally from $98 trillion in 2000 to $270 trillion in 2005, and is coming into its own as an asset class, according to new research from TowerGroup.

Over the next three years, TowerGroup expects buy-side derivatives usage to explode, bolstered by the shift to electronic trading, search for alpha, and more accommodating regulations, which allow derivatives usage in pension funds and institutional money management.

"We are seeing enormous demand for derivatives from the buy-side, particularly relative to hedge funds, following the relaxation of restrictions on using derivatives for managing money," said Dushyant Dushyant Shahrawat, research area director of the Securities & Capital Markets research service at TowerGroup.

"Yet, for many, the derivatives market remains an enigma that is both overly-complex and difficult to grasp."

The research predicts that global IT spending in derivatives will grow 18 per cent annually over the next three years, compared with four to six per cent for equities and fixed income. Top areas of spending will be risk management, processing and pricing/analytics.

It also concludes that derivatives are energizing the agency brokerage business and Wall Street firms have been leading their buy-side and hedge fund relationships with derivatives offerings.

Regarding the global spread of derivatives usage, US and European firms lead the rest of the world, followed by Japanese institutions. Yet TowerGroup believes the fastest growth area for derivatives globally will be seen in emerging markets.

Mr Shahrawat added: "Playing the derivatives game requires a strong balance sheet for structured products, ability to execute and process trades, talented and innovative people to generate ideas for clients, and a strong cash business as support.

"Brokerage firms that will succeed in the market will have the vision to combine cash and derivatives under the same management, so expertise is leveraged across products and clients can be serviced across the entire capital structure."

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