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Risk - January 16, 2004

Derivatives in portfolio investing

An interview with Rudolf Ferscha, CEO of Eurex

Rudolf Ferscha is member of the Management Board of Deutsche Börse, where he is responsible for the derivatives markets division, and CEO of Eurex. Prior to that, he worked for the Goldman Sachs Group L. P., the London SFA regulated securities trading house, First Austrian International, and as a corporate finance and capital markets lawyer. In this interview, Rudolf Ferscha speaks about Eurex's expansion to the U.S. market, the use of derivatives in investment funds and the Eurex partnership with EDHEC.


Rudolf Ferscha

Eurex, in a step towards its expansion to the U.S., has recently joined forces with the Board of Trade Clearing Corp., the former Clearing House of the Chicago Board of Trade. What do you think Eurex's strengths are in comparison to the existing derivatives exchanges in Chicago?

Rudolf Ferscha: Eurex US will be a U.S. regulated exchange and plans to launch on February 8, 2004, subject to approval from the Commodity Futures Trading Commission (CFTC). The long-term clearing partnership between Eurex Clearing AG and The Clearing Corporation will enable the two clearing houses to clear U.S. Dollar and Euro-denominated products that trade on both Eurex and Eurex US.

Eurex will be the highest value-added service provider in the U.S. derivatives market. Through the global clearing solution, we will offer our customers a choice of the premier clearing solutions in the U.S. and Europe. For our new U.S. products, we will use Eurex technology, on which already more than 80 percent of all U.S. bond futures are traded. Our customers will be able to continue to use exactly the same infrastructure they are using now. This partnership with the Clearing Corporation will accelerate growth throughout the industry

For the first time, customers will be able to leverage their existing infrastructure to access U.S. Dollar and Euro-denominated products and to substantially increase the efficiency of capital employed. Members and their customers will benefit from cross listings in the U.S. and Europe, as well as full fungibility of the products. Customers will have access to additional product ranges at no additional infrastructure cost on a global basis. At the same time they will benefit from lower margin requirements, cross margining and reduced collateral requirements through the use of collateral pools for a wider range of products.

In the European Union, the new UCITS directive has brought about changes for the use of derivatives by investment funds under the UCITS regime. How do you think this will influence your business?

Rudolf Ferscha: Following its last revision in 2001, the UCITS Directive now allows investments in derivatives. The derivative exposure is limited to the total net value of the portfolio and the use of derivatives must be included in the prospectus. By 2005, the Commission will report on extending the UCITS passport to include, among others, hedge funds and on whether increased derivative exposure is acceptable in view of minimum investor protection standards.

Eurex welcomes a balanced acceptance of derivative products by the EU and national regulators. This will certainly increase institutional investors´ interest in derivative products and expand their opportunities to implement derivative strategies for portfolio protection and yield enhancement.

On the other side of the spectrum of investment vehicles, hedge funds have seen rapid growth compared to the traditional investment industry. What does the alternative investment industry represent for Eurex?

Rudolf Ferscha: The general interest in alternative investments has significantly increased over the past years. This is reflected by the increasing number of hedge funds which has reached over 5,000 worldwide in 2003, up from around 500 in 1990. The assets under management increased by a factor of fifteen up to over USD 600 bn in the same time period.

The reasons for this tremendous growth are multifaceted. Hedge funds have an absolute return focus and utilize a broad spectrum of cash and derivatives products to extract relative value and profit from rising as well as falling markets.

In contrast to the traditional funds, short selling and the extensive use of derivatives represent the main instruments used additionally by hedge funds. Eurex offers hedge funds managers a competitive, diversified and liquid product portfolio facilitating complex trading strategies.

Looking forward, consistent regulation for alternative investment is desired by many, evidenced by discussions of the Purvis Report taking place in the European Parliament. These discussions are of particular interest since the current UCITS directive does not cover rules and regulations for hedge funds. Instead individual and very different national regulations co-exist and compete.

The German Bundestag and Bundesrat have recently approved the Investment Modernization Act admitting hedge funds and regulating them for the first time in Germany. The introduction of hedge funds answers demand by German institutional and retail investors for alternative investments. The new regulation, which will be effective as of January 1, 2004, reflects a liberal approach aiming to increase the attractiveness of Germany as a financial center and to increase investors´ understanding of the role of short selling as well as derivatives products in absolute return products.

Eurex sponsors the EDHEC Risk & Asset Management Centre's research programme on asset allocation and derivative instruments. For which reasons did you choose to establish this partnership with EDHEC?

Rudolf Ferscha: In addition to being one of the top five business schools in France, Edhec develops its research concentrating on the practical application of the results. This is particularly relevant for the institutional investors and traders who use Eurex products. Much of the research done by Edhec has inherent relevance for Eurex products in both the traditional and alternative asset management industry. In particular, Edhec’s work on indexes and benchmarking, as well as sector and style timing, attracted Eurex to examine how these themes could be further developed to examine the use of derivatives in portfolio investing. Finally, working together with leading academics such as Noël Amenc and Lionel Martellini supports Eurex in providing its product users with current research advancing the effective use of derivatives.