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Property price collapse highlights value of derivatives market

Against a backdrop of the most savage falls in UK commercial real estate values ever recorded – IPD’s UK index fell 3.6% in November and 3.7% in December – the real estate derivatives market has not been found wanting.

With volumes reaching record levels despite unprecedented widening in spreads, the end of 2007 and beginning of 2008 might eventually be the period when the market came of age.

Volumes traded in 2007 reached £7.21 billion compared with £3.88 billion in 2006 and there is now £9 billion in notional trades outstanding. Trades in the fourth quarter of 2007 reached £1.662 billion – with 214 contracts being traded, the highest number ever – compared with £1.66 billion in the third quarter, £970 million in the second quarter and £2.72 billion in the first quarter.

"The market has grown significantly," says Nick Nabarro, spokesman for IPD in London. A total of 22 banks are now licensed to trade real estate derivatives by IPD, with 11 of those licences to trade more than one market – although the UK market still remains the largest – and a further four banks are in talks to gain licences. "There has been a long-term educational push by IPD, banks, brokers and other parties and it happened that the peak of this educational cycle coincided with the sub-prime crisis," says Nabarro.

Nabarro believes that the market is reaching critical mass – property owners and fund managers are more comfortable with derivatives – just as the potential uses of derivatives are made more obvious by the dramatic changes in the real estate market.

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