Portfolio Management - June 26, 2012

Volatility derivatives have been embraced by investors as a way to pinpoint volatility risk - an interview with Michael Peters

In this month's interview, we talk to Michael Peters, Member of the Eurex Executive Board, about the recent EDHEC-Risk study "The Benefits of Volatility Derivatives in Equity Portfolio Management," Eurex Exchange's ambitions globally in the area of volatility derivatives, the future evolution of Eurex Group's business, and Eurex's support for EDHEC-Risk Institute's research.

Michael Peters

EDHEC-Risk Institute has just released a new study, entitled “The Benefits of Volatility Derivatives in Equity Portfolio Management,” which was produced with the support of Eurex Exchange. Why do you think it is useful to produce and disseminate state-of-the-art research on the use of volatility derivatives in the optimisation of equity portfolios?

Michael Peters: There is still a controversial discussion in the industry whether volatility is either just a further “tradable” product or even an asset class of its own. Eurex Exchange looks to achieve two goals at once by supporting such a comprehensive academic study: firstly, help establish an academic analysis for the European volatility landscape that has not been available to date. And secondly, acting as the link between the academic world and the derivatives industry by virtue of operating the leading market for European equity based derivatives.

What do you think are some of the key takeaways from this research?

Michael Peters: One definitely is the confirmation of a common assumption that the correlation between the return on volatility indexes and return of equity indexes are strongly negative. The finding on negative correlation is in particular relevant for the European market, as this correlation had already been proven for the US market. Even a modest allocation to volatility derivatives allows investors to create equity portfolios that have more attractive risk/return profiles, with a substantial reduction in maximum drawdown levels. Both results should be a good foundation to further increase institutional clients' confidence in trading a product that will help them to achieve their different objectives in a more efficient and reliable way.

While this piece of research is of global relevance, it was managed by EDHEC Risk Institute Asia. What is the policy of Eurex Exchange globally in the area of volatility derivatives and how does it relate to your ambitions in Asia?

Michael Peters: Volatility derivatives have proven themselves to be a popular asset class that allows a variety of investors across the globe to hedge or trade on volatility in the markets. Given the market turbulence over the last few years, volatility derivatives have been embraced by investors as a way to pinpoint volatility risk. Our strategy is to offer a broad range of benchmark volatility derivatives that provide tailored exposure to European volatility to support that demand. Asian investors specifically have expressed keen interest in our volatility derivatives. And currently Eurex Exchange participants in major financial centers around the globe, with the exception of the US, actively trade Eurex volatility derivatives. In the US, we have applied for CFTC authorization for our volatility futures as well, to extend our offering to US-based customers.

EDHEC as well as Eurex Exchange recognize the ever growing importance of the Asian markets. The equity derivatives markets are still in their early stages in many countries in Asia. Hence, more education is needed to change the public perception and to aid investors to make sound financial investments. In this respect, both parties are relying, above all, on education and partnerships. For example, we have a very successful cooperation with the Korea Exchange (KRX) in trading a derivative on the local benchmark index, KOSPI, which is in great international demand.

In addition, we also have partnerships with renowned academic institutions in Asia, like SAIF, the Shanghai Institute of Finance, a division of the Jiatong University in Shanghai or the CUHK (Chinese University in HK) and NTU (National Taiwan University) where we supported them to install real-time trading labs. Since the launch of our Asia Training & Education Initiative in August 2010 more than 3,000 students and industry professionals have been trained by our instructors in Asia.

The current period is one of flux for exchanges globally and the financial crisis is still recent. How do you see Eurex Group’s business evolving over the next few years?

Michael Peters: Our business will see tremendous changes in the way the financial markets are supervised and regulated. Based on the G20 commitment from September 2009, we will see a shift from bilateral trading of OTC derivatives with no central clearing to an environment of electronic traded and centrally cleared derivatives. Regulatory initiatives like European Market Infrastructure Regulation (EMIR) and Dodd-Frank are the key drivers for this paradigm change.

As one of the leaders in the exchange industry, we aim to offer our expertise and services in this process and new landscape. Thus, on the clearing layer, we have started to expand our product and service range to currently unregulated and uncollateralized markets. This move is in response to changes in customer needs as well as the regulatory framework in the wake of the financial crisis. Among others, we are excited to work closely with the leading OTC derivative dealers in rolling out our EurexOTC service for IRS clearing. Our objective is to deliver the market leading solution for OTC clearing in Europe. Our customers will benefit from a broad product coverage across asset classes, full portfolio based risk management across listed and OTC products, strong asset protection and a broad collateral universe.

Second, we will continue to tap into new geographic growth areas and approach new customer groups in innovative ways, harnessing our own sales efforts to leverage key multipliers in key global growth areas. We recognize that potential partners in these areas see partnership with us in areas such as technology and products as a win-win situation.

Eurex is one of EDHEC-Risk Institute’s longest standing partners, having first sponsored EDHEC-Risk research in 2003. Could you tell us why you have supported and continue to support this research?

Michael Peters: As a longstanding partner of EDHEC-Risk Institute’s research, we are pleased to have been able to support cutting-edge academic research on optimal approaches to investing in volatility. We see EDHEC’s activities and this publication specifically as evidence of the potential usefulness of trading volatility derivatives in an equity portfolio management context and feel that it will be welcomed by the international investment management community.

We are convinced that studies like this will add value for all our institutional clients, as it outlines and substantiates the trading and portfolio management applications for volatility products. In today's market, volatility plays an ever increasing role and can facilitate a successful asset allocation process across a wide range of asset classes.

About Michael Peters

Michael Peters has been a member of the Executive Boards of Eurex Zurich AG, Eurex Frankfurt AG and Eurex Clearing AG since 2006. He is also a member of the Management Board of Eurex Deutschland. As a Board Member, Mr. Peters is responsible for sales and marketing, including business research, and for corporate business development in Asia and the Middle East.

In addition, he accounts for the Eurex Sales & Representative Offices in Chicago, Hong Kong, London, Paris, Singapore, Tokyo and Zurich.

From 2001 to 2006, Mr. Peters worked at OMX AB in Stockholm as Head of Projects as well as for Strategic Initiatives. Besides important projects for exchange and clearing organizations in the U.S. and Asia/Pacific, his duties included the evaluation and implementation of strategic initiatives for the next generation of trading and clearing systems. From 2000 to 2001, he was OMX AB’s Managing Director of Trading Technologies in Frankfurt and Chicago, responsible for Business Development.

From 1991 to 2000, Mr. Peters held various management positions within Deutsche Börse and Eurex, as well as Deutsche Terminbörse (DTB), a predecessor of Eurex, with his last role being Head of Xetra Market Development. In this position, he was responsible for the setup of the business development section and directly reported to the Executive Board of Deutsche Börse AG.

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