Overview of Equity Derivatives

Growth in equity derivatives, such as options, swaps and variance swaps, has been strong, with the total notional value outstanding for equity derivatives more than doubling to $5.5 trillion at the end of 2005 from $2.4 trillion three years earlier, according to the International Swaps and Derivatives Association (ISDA®).*

Investors, such as pension funds, are increasingly adding these products to their portfolios to protect against market volatility. What's more, financial research firm Boston Consulting Group forecasts that investment banking revenue related to equity derivatives will reach $20 billion this year compared to $14 billion in 2004.

Like credit derivatives prior to concerted efforts to automate operational practices, equity derivatives processing is performed mostly through manual, paper-based methods, which are inherently prone to errors. According to the ISDA 2006 Operations Benchmarking Survey, equities, along with non-vanilla swaps and commodities, are the least automated product in the OTC derivatives market. The survey also noted that errors in trading non-vanilla equity derivatives more than doubled to 20% last year and that the level of unconfirmed trades and days' outstanding of such trades were also up.

The market for equities derivatives is multi-dimensional, according to Gina Ghent, DTCC vice president, Business Development, which means it requires greater attention and documentation efforts for both market participants and DTCC.

"ISDA has worked with the market to create general terms confirmations or Master Confirmation Agreements [MCA] for the various equity products and regions," said Ghent. "Once MCA execution occurs, market participants can then use Deriv/SERV's equity derivatives service to match the trade-specific details for each trade, and provide a quick and efficient means to execute confirmations."

*ISDA® is a trademark of the International Swaps and Derivatives Association.