This is a key finding of early 2003 research by Greenwich Associates, which indicates that equity derivatives usage is evolving in a new direction. Greenwich Associates consultant Jay Bennett said: "There has been a fundamental change in the entire institutional approach to equity derivatives".

Greenwich Associates research reveals several major shifts in the North American equity derivatives market. While traditional futures and listed options account for a total of 80 per cent of the volume traded in this market, the proportion of volume traded in exchange-traded funds (ETFs) more than doubled, from 4 per cent to 11 per cent.

Much of this change can be attributed to the fact ETFs can be shorted and thus are appealing to hedge fund investors, an increasingly important component to this market.

Meanwhile, the proportion of business controlled by derivatives specialists has shifted, plunging from 60 per cent in 2001 to 20 per cent this year, as the proportion controlled by portfolio managers jumped from 16 per cent to 45 per cent.

How Europe compares

Average equity derivatives trading volume by institution in North America rose from US$6 billion to US$7.4 billion, a 23 per cent increase. That is more significant than the 15 per cent growth concurrent Greenwich Associates research recorded in the European market.

Futures are the most commonly traded product in both markets, but particularly so in Europe (72 per cent of the total equity derivatives market) compared to North America (58 per cent of the total market.) The use of vanilla OTC options is far greater in Europe, where it represents 14% of total volume, as opposed to just 5 per cent of North American volume.

Consultant John Colon points to "a marked shift in the control of equity derivatives transactions in Europe, with derivative specialists‚ control declining from 59% to 37%, and portfolio managers rising from 12% to almost 30%. The changeover in Europe is less complete, but the trend is clearly in the same direction."

Electronic trading: The future

Less than 10% of North American institutional trading volume in listed options on individual stocks and listed equity index options are being routed directly to exchanges via electronic trading systems, and only 16% of listed equity index futures are being so routed.

Among users of these trading systems, the proportion of listed equity index futures that is being routed directly to exchanges via electronic systems is pretty high, 49%. At institutions with equity derivatives trading volume of less than US$1 billion annually (on the lower end in volumes traded, among those institutions Greenwich Associates studied), that proportion is about 80%.

Background Note: Greenwich Associates is an international research-based consulting firm in institutional financial services worldwide. Greenwich studies provide benchmark information on best practices and market intelligence on overall trends. Based in Greenwich, Connecticut, with additional offices in London, Sydney, Toronto, and Tokyo, the firm offers over 100 research-based consulting programs to more than 250 global financial-services companies.

From January to March 2003, Greenwich Associates conducted interviews with 129 institutions in the United States and Canada who invest in equity derivatives. Interview topics included market trends, service provider assessments, and compensation.