SWITZERLAND
A EUROMONEY SURVEY - MARCH 1996
A UNIQUE MARKET
Today's global financial markets are without frontiers. Reading most financial publications, one would think that doing financial business in London, Tokyo or Zurich is merely engineering and selling generic products to local markets.
In reality, fundamental cultural differences exist in the demand and usage of financial products even amongst neighbouring countries. Switzerland is no exception, and analyzing the market for derivatives products in this country is an interesting exercise in order to understand the future of the derivatives business in general.
Although a small country, Switzerland presents a extremely diversified financial profile:
* Swiss corporates include some of the biggest European multinationals alongside big domestic companies;
* Swiss sovereign entities (confederation, cantons, municipalities) have only recently faced significant borrowing needs and this trend is likely to continue;
* The Swiss financial sector has traditionally been very important and diversified: it combines three giant, universal groups, present internationally in every area of finance; a unique collection of private banks; and a strong network of local commercial banks.
Switzerland therefore offers the promising potential of a very diversified market in a limited geographical area; but it is also a country where caution is a national tradition. How do these contradictory factors affect the market for one of the most sophisticated areas of finance, derivatives?
USAGE BY CORPORATE CLIENTS
Liability management In most countries, derivatives products are primarily used by corporate clients for liability management purposes as they often have significant borrowings. Switzerland is the country of cash-rich corporates. Some of the bigger corporates, and especially the big multinational companies, have some debt financing, denominated in various currencies that could justify the use of derivatives products. This, however, has been fairly limited in the past and has certainly not been comparable in volume and sophistication to the type of business seen in other European countries. This results from a very conservative approach to liability management involving only plain vanilla products such as interest rate and currency swaps, and, in a very limited way, standard options on interest rates.
What can be said of this clear conservatism? On the one hand, it is obvious that a well-managed and controlled but more active use of simple and complex derivatives for liability management purposes could bring substantial savings to Swiss corporates. On the other hand, this conservative approach has prevented the occurrence in Switzerland of any of the excesses that have been experienced by some corporates in other countries such as the US. Therefore, there is no
a prioricase in Switzerland against the use of derivatives, but rather a pragmatic and open approach. This sector of the market will slowly develop as active liability management becomes increasingly important for these clients.
Asset management A large part of the derivatives business executed with corporates is in the field of asset management. The greater liquidity of simple interest rate derivative products such as swaps, compared with that of Swiss bonds, has allowed a substantial volume of business to develop. These instruments are seen as well-suited for the dynamic management of fixed-income assets. In the area of equity, classical tactical strategies such as sale of covered calls or purchase of puts are also relatively common. The simplicity of instruments used is a natural consequence of the conservative bias attached to corporate financial asset management. However, as with liability management, CSFP believes in the virtues of a slow but continuous learning process which will ensure a natural growth for this area of the business.
Foreign exchange risk management Swiss multinationals in particular, with an extremely significant presence abroad and one of the strongest base currencies in the world, have tremendous exposure to foreign exchange risks. To date, they have focused on basic products for managing these risks (spots, forwards, short-dated plain vanilla options). However, if the Swiss franc remains overvalued in the coming years, it is probable that the competitive pressure brought by currency disparity will encourage Swiss companies to use more sophisticated derivatives in the area of foreign exchange management, a trend already emerging in other geographical markets.
Other applications in the corporate market Today's scope for application of derivative products goes far beyond risk management in traditional areas such as interest rate, foreign exchange and equity. First, more underlying risks naturally present in corporate businesses such as commodities price or credit risk can be efficiently managed by derivative products. For example, the past two years have seen a development of credit derivatives used by corporates for hedging credit risks generated by projects or activities in emerging markets. Swiss corporates have been at the forefront of this development.
Additionally, increasingly complex corporate finance transactions, in which a derivative might be only one of the components, are taking place today. These transactions do not belong to the traditional derivatives business executed in the treasury department of the firm. They usually involve its top management or even the board, and tackle fundamental issues for the company. On the bank side, they require the combined efforts of very different departments with different cultures and expertises.
Having a unique derivative service provider with knowledge in all types of underlyings and markets, rather than several scattered derivatives departments, becomes a key success factor for inventing, structuring and executing these transactions.
USAGE BY SOVEREIGN ENTITIES
Sovereign clients across the world have been a traditional source of business for derivatives providers: Numerous derivative transactions have been entered into by these clients, either attached to primary funding transactions aimed at tapping a given investor market, but incorporating unwanted currency or interest rate risk, or as secondary tools for managing financial risks embedded in existing borrowings. Most of these transactions are plain vanilla (interest or currency swaps).
Swiss sovereign entities' need for borrowing is only relatively recent, at least in meaningful amounts. However, this situation has naturally implied a fair amount of primary and secondary derivative transactions in the past, and there is no reason to see why this area of the market should not develop significantly in volume over the coming years.
USAGE BY FINANCIAL INSTITUTIONS
Trading and liability management
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