CEE Equity Derivative Market Developments

Derivative market development in CEE

Warsaw October 2013 Douglass Welch +44-207-826-6882

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Current Themes dominating the market

The CEE markets have benefited from the pursuit of ‘growth’ and flood of speculative activity over 2003-2008. The CEE markets are now being subjected to considerable change impacting international investors.

Rising Regulation

Intense focus on the cost of capital

Decreasing market participation & lower liquidity

A flight to the deep pools of market liquidity

Structural Change of Markets

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Themes & Impacts

1. Rising Regulation

Currently the entire derivative market is renegotiating ISDA documents covering all OTC trading. Final terms of the required changes were release on 10-Aug, implementation was due 20-Sep.

Basel II and Basel III are causing stress testing of collateral assets, the cost of holding such assets (generally and by trade)..

Tax Regulations are reinforced, rational of many trading strategies deemed unethical and dividend-related trades now draw extra regulatory attention.

2. The Cost of Capital

The Proprietary trading activity becomes fully costed; risk-taking requires much high capital reserves in stress-testing.

Moves toward central clearing counterparts (CCP) stretches available capital. Re-rating of acceptable collateral and tightening ranking of assets further impact costs.

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Themes & Impacts

3. Decreasing market participation & lower liquidity

Proprietary trading activity sharply lower. Fewer Hedge Funds focus on CEE opportunities and assets allocated to CEE equity market shrinks.

Liquidity of WIG20 index options suffers, no liquidity in BUX or PX. RDXUSD volumes decrease 25%. Index Arbitrage flows halt, decreasing volume & widening rich/cheap trading ranges.

4. A flight to the deep pools of market liquidity

Retreat from illiquid indices, toward proxy assets : SX5E / SPX / EEMs and various ETFs. This trend was affordable while Correlation was high, but as it falls again it forces re-assessment – net exit of illiquid markets: RDX wins over RIOB. Local participants dominate flow in RTS50 / WIG20

5. Structural Change of Markets

Exchanges respond with new contracts, but fundamental liquidity problems remain. Consolidation of ICE/Euronext; MICEX/RTS and migration of Wiener Bourse ATX derivs and stock options to EUREX leaves PX and BUX to migrate to WSE(??)

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Response to the Challenges

Speculative volumes need to be encouraged to return, while avoiding excessive regulatory burdens

Regulatory Clarity:

Offshore Tax policy on Polish share trading requires liberalisation – but this is contrary to trend

Pension Funds should be encouraged to responsibly use derivatives

Exchanges - changes suggested:

Change in corporate reporting to ensure it comes via the Listed Exchange or disclosure is uniform & robust. Corporate dividend policies are not consistent adding unnecessary volatility

Create specific Quarterly Roll-over contracts to increase visibility on Futures roll fair-value

Accept EGUS format Give-Up agreements.

Closed nature of BUX / PX / WSE prevent larger global clearers from providing access due to cost vs. volumes. Local knowledge stops within Global clearers – end clients do not get the benefit, their contact to the market is passive, open this system up allowing local brokers to execute for Internal clients & ‘give-up’ to global clearers