The Hindu Business Line : `Derivatives are like race cars'

A derivative needs to be used by professionals. It is like a race car, part of the performance comes from the machine and part from the experience and capability of the driver.

MR OMER HEVLIN, SALES DIRECTOR (ASIA), SUPERDERIVATIVES

In finance, derivatives are financial instruments whose value changes according to the changes in fundamental variables. Just like the Americans have heard about the term `sub-prime' for the last 12 months, Indians too have heard a lot about derivatives for the last month or so. Futures, forwards, options, swaps and what not? Financial products based on such complicated mechanisms will require more transparency.

But while transparency is certainly an issue as is understanding, the onus is also on the taker, that is, the company or the bank on its behalf. Systems and processes then become even more crucial. "It is like a race car, part of the performance comes from the machine and part from the experience and capability of the driver," tells Mr Omer Hevlin, Sales Director (Asia), SuperDerivatives (www.superderivatives.com). SuperDerivatives is the benchmark for derivatives pricing and the leading provider of multi-asset front-office systems, risk management, revaluation and online options trading solutions.

Indian banks such as Centurion Bank of Punjab have leveraged their expertise to manage multi-asset portfolios of exotic options and structured products and calculate exposure in real time. But that's not enough. "Because they are still running their risk using TV (terminal values), rather than real time rates and volumes," Mr Hevlin told Business Line in course of an e-mail interaction from Singapore.

Excerpts from the interview:

Derivatives market is often shrouded in conscious secrecy or veiled transparency. Right from plain vanilla to exotic derivatives, what has been your experience?

The market participants clearly require the right tools to arrive at the right price and fully understand the risks involved. Our goal is to lift the veil of secrecy and bring transparency to derivative pricing and valuation by empowering any market participant to obtain prices that reflect the fair market value for any derivative instrument, for any asset class.

What would be your take on the understanding of financial risks taken aboard by Indian companies?

We believe that the position taken by a corporate needs to be well analysed and risks have to be clearly anticipated.

How can a product meant to serve as an insurance against fluctuating currency backfire?

The product needs to be used by professionals. It is like a race car, part of the performance comes from the machine and part from the experience and capability of the driver.

SuperDerivatives is said to have its own pricing model. What makes it so special and unique?

Prior to the advent of SuperDerivatives, options practitioners faced two major obstacles. The first one was price opacity. Practitioners could use the ubiquitous Black-Scholes formula to price vanilla options and with the same framework price all exotic options, although it was well known that the Black-Scholes approach produced prices significantly different than the actual market prices.

The leading traders from the top investment banks were able to compensate for Black-Scholes deficiencies by leveraging their experience in the market together with their vast computational resources to accurately price options - and those prices were closely guarded.

Closely guarded prices, isn't that dangerous?

Thousands of less experienced professionals who traded options regularly - mostly from the buy-side (corporations and investment funds) - lacked the tools and expertise to price them accurately. As a result, the buy-side was dependent on the sell-side (banks) for trade design, price fairness and post-trade revaluation for complying with accounting standards in their P&L reporting. The inability to price options accurately made many people on the buy-side less active in options and severely limited the benefits that options could provide them and the world economy as a whole.

You were talking about the second challenge.

The second challenge faced by options market practitioners was a lack of systems and infrastructure to support options business activity. Missing were effective solutions for pricing, analysis, market data feed, risk management and more. Only a few of the world's largest investment banks have the internal resources to tackle those challenges in-house.

According to you, what would be the total exposure of companies from Asian countries in the forex derivatives market?

The marked-to-market losses in India are estimated to be between Rs 12,000 to 20,000 crore and the total market size is Rs 1,27,86,000 crore.

What are the gaps in skills and competencies that you find among the fresh crop of talent entering the derivatives sphere?

The participants need to have a complete understanding of the extent of risk/losses that they would be exposed to when they enter into a structure.

More specialised courses need to be introduced by the educational institutions/ organisations. Professional and well-trained staff needs to be handling the treasury functions in small and medium enterprises (SME) which is currently not the case. For example: A person handling finance and accounts generally ends up taking care of treasury.

Do banks too need courses in risk management?

Because they are still running their risk using TV values, rather than real time rates and volumes, same goes for their Greeks and credit exposure. (The Greeks are a collection of statistical values expressed as percentages that give the investor an overall view of how a underlying asset has been performing. These statistical values can be helpful in deciding what options strategies are best to use.)

Training, of course, would help as derivatives is an evolving market with products being introduced in the market on a regular basis. Hence, staying on top of the situation would help containing risks.

They need to be aware of issues like the volume input they are using to evaluate their risks is based on ATM volumes (an option is At-The-Money if the strike price is the same as the current price of the underlying security on which the option is written) volumes which are not enough for deep OTM options (Out-of-The-Money are those that would be worthless if they expired today).

What are the `must checks' that companies should ensure before entering into derivatives contracts?

Do have the capability to assess future exposure of each deal and compare it to valid credit client before signing the deal.

Do get the market Greeks and understand them before you sign a deal.

Do follow the RBI guidelines and do not be tempted into transactions which don't address clients underlining exposure and financial hedging needs.

Do invest in sales-force education.

Do equip the sales-force with advanced sales tools and real time pricing platforms which are based on bank rates so that traders can control prices/volumes/spread on a real time basis.

Do be able to provide your client with a clear Term Sheet of any transaction in real time.

Do know what the maximum losses are that could be incurred while entering into a deal.

Do take proactive measures to cut down on losses when the view goes against you.

D. MURALI

KUMAR SHANKAR ROY

www.InterviewInsights.blogspot.com

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