ISDA PRESS REPORT - DECEMBER 28, 2001

REGULATORY
	*	US Fed, Treasury, SEC, CFTC Survey Recommends No New Swaps
Law - Dow Jones

TRADING PRACTICE
	*	2001: A Derivatives Odyssey - FOW

US Fed, Treasury, SEC, CFTC Survey Recommends No New Swaps Law
Dow Jones - December 28, 2001
By Rebecca Christie

WASHINGTON -- U.S. financial market regulators recommended no new
legislation to regulate swap agreements involving customers with low net
worth, according to a study released Thursday by four federal agencies.

The U.S. Treasury, the Federal Reserve, the Commodity Futures Trading
Commission and the Securities and Exchange Commission issued a joint report
on "retail swaps" Thursday assessing whether there was a need for further
regulation.

A swap is a type of financial transaction in which two parties agree to
exchange payments or securities over a period of time. Swaps contracts are
generally used by large institutions to hedge risk, such as interest-rate
risk or currency risk.

Retail swaps involve customers who are not "eligible contract participants"
under federal law. This group includes individuals who have less than $10
million in assets, or less than $5 million under certain conditions, as well
as non-financial entities that have total assets of less than $10 million
and do not use swaps as a normal part of their business.

Retail swaps are not covered under recent legislation that regulates
derivatives. The study released Thursday surveyed representatives from
dealers, a derivatives trading system and a trade association.

The joint report said that the four agencies do not currently see a need to
regulate most swaps involving these small customers, with the "possible
exception" of energy swaps. Should regulators see a need to oversee energy
swaps, current legislation appears to give the CFTC some latitude to act,
the report said.

If interest in energy swaps were to outpace the current scope of the CFTC's
authority, Congress might wish to step in at that time, the report said.

2001: A Derivatives Odyssey
FOW - December 2001

The derivatives industry in 2001 has experienced continued consolidation
among users and exchanges. Electronic trading practices have further
penetrated into traditional procedures, while exchanges have reaped healthy
revenues from derivative contracts.

One product that has swept across the world's derivatives exchanges this
year is the single stock future. London International Financial Futures and
Options Exchange (Liffe) launched its Universal Stock Futures in January
2001, to great fanfare but only moderate success. Nevertheless, exchanges in
Europe and Asia rushed to jump on the single stock bandwagon. Anxious not to
miss out on the action, the US repealed the Shad-Johnson accord, in place
since 1982, which prevented investors betting on the future price of
individual stocks. The repeal was set to become effective on 21 December,
but has since been postponed to the end of March 2002. Bill Rainer, who was
chairman of the Commodities and Futures Trading Commission (CFTC) at the
time of the repeal, notes that while the bill is generally sound, it is
still within the period of industry comment.

Rainer has since moved on and is currently heading one of the newest single
stock ventures, between Chicago Board of Trade (CBoT), Chicago Mercantile
Exchange (CME) and Chicago Board Options Exchange (CBOE). This remarkable
alliance pools the resources and liquidity of the three exchanges, giving
serious competition to American Stock Exchange (Amex) and the joint offering
between Liffe and Nasdaq. While the single stock futures will be offered to
alt qualified market participants, Rainer feels the product will not be
suited to all sectors of the market. "They are likely to be more attractive
to the institutional sector than the individual sector because institutions
have the resources to educate themselves about the value of the product and
its place in their strategies," he explains. Nevertheless, he is confident
in the product's value as a useful risk management tool for any
practitioner. However, confidence in single stocks is far from unanimous.
Not withstanding the hype, dissenters note that the volumes in single stocks
are subdued around the world. The start of trading in the US may give them a
much-needed boost but, as yet, the money is going elsewhere.

"The evolution of the index derivative product business has been the most
significant development in 2001," says Uwe Velten, at European derivatives
exchange, Eurex, and he thinks it will continue. "This is just the beginning
of a strong product group. Index products are one of the most intelligent
tools to manage risk with," he assures. "As they are a trend in the market,
we encourage them in our portfolio." Velten notes that the importance of
index products has increased with their expanding geographical scope. "For
years, futures and options on the Dax was our only index product. Then we
expanded our product offering beyond national products." ParisBourse, Swiss
Exchange, Deutsche Bourse and Dow Jones created Stoxx in early 1998 to
provide a European-wide family of indices. "When Eurex was created, we
captured all euro Stoxx business, and today we average around 220,000
contracts a day, and this is growing,"

Velten explains. "Now we have moved into global offerings, with Nymex 50
futures and options and sector index products from Dow Jones, which are
growing from a small base. This is what the future will bring. The business
is growing in Europe with sector index products and, globally, with the new
Global Titans products." Eurex has experienced 80% growth in index products
this year, compared with 250/0 growth in capital market products and the
fixed income sector, and 500/0 growth in stock options.  Eurex's five-year
German government bond (Bobl) contract was the fixed-income headline grabber
of 2001. When one market player successfully manufactured a bobl squeeze in
March by cornering the market in the physically deliverable futures
contracts, Eurex needed to act fast to avoid a repeat performance in
September. In an overhaul of its securities regulations, the exchange
introduced position limits on the futures contracts and, crucially,
rectified the discrepancy in penalty charges for the late delivery of
underlying securities with drastic cuts. The fixed income community offered
only timid approval however, and few believed a squeeze could be fully
avoided.

Sensing opportunity in the air Euronext Paris re-launched its five-year
European government bond futures contact in a bid to capture market share
from disenchanted Bobl traders. A deal between Eurex and the German finance
agency Bundesfinanz Agentur finally stretched the September Bobl, with an
agreement to supply additional bonds in case of another shortage. By
extending the pool of deliverable securities the Bobl looks set for an easy
ride this December. However, the long-term future of government debt markets
in general still hangs in the balance.

Both sides of the Atlantic have suffered a dearth of government bonds amid
treasury buy-back programmes and cuts in issuance this year. Most recently,
the US Treasury stopped issuing 30-year bonds in November. Subsequently,
investors have begun to favour the swaps market to hedge their interest rate
risk. Many market sources and the Bank for International Settlements claim
that interest rate swaps are the leading candidate to replace government
securities as the leading capital market's benchmark. In March, as the
fragmented government bond market continued to shrink amid high-profile
contract squeezes, Liffe entered the fray, hoping to mop up business with a
family of euro-denominated futures on interest rate swaps, collectively
named Swapnote. Contrary to the many doubts over the product's ability to
capture liquidity from the OTC market, it attracted substantial interest.
The success of the contract in Europe convinced Liffe to make plans for
expansion into the US market with the euro-denominated swap futures, with
speculation of a US dollar swap contract to follow.

Witnessing the success of Swapnote, and conscious of its faltering T-bond
future, CBoT introduced a suite of swaps derivatives that made a promising
debut in November. Nicholas Neubauer, chairman at CBoT, explains the
concerns underlying the decision. "Earlier this year, there was a feeling
that the amount of publicly available Federal debt would decline to zero
over the next five to ten years. We, therefore, wanted to offer our
customers a swap contract as an alternative tool." While these new swap
contracts have proved highly popular, they must be seen in perspective - for
example, while Liffe's daily average for Swapnote is around 20,000
contracts, Eurex's ten-year bond averages nearer 500,000. Nevertheless, it
is a product class with great potential. As Neubauer says: "If it is going
to be a winner, it will be a big winner."

Volumes in the options market have been thriving in 2001. A single day
record of 2.7m was notched by CBOE in April, which is now in competition
with five other options exchanges in the US. "We are very pleased with this
year's performance, especially in light of the increased competition, both
domestically and internationally," says Edward Provost, executive vp at
CBOE. However, all has not been plain sailing, and the options market has
suffered upheaval with the move to decimalisation. "In the case of options,
this change required a substantial technological effort to trade decimals
instead of fractions," comments Provost. "It also has a significant impact
on the way options traders operate, even more than on the stock side." The
move to modernity was sanctioned because a stock price quoted in fractions
forces an artificially wide spread. But while decimalisation allows for many
more potential price points for a stock, it subsequently creates an
amplification of complexity for options pricing. "This increased capacity
for market quotation results in an increased number of market floatation
updates," explains Provost. "So it was all about operational preparedness,
and adapting systems for a surge in business. For CBOE, the change to
decimals went very smoothly."

Electronic trading
Technological upheaval has affected many derivatives exchanges in 2001 and
the troubles at CBoT have been symptomatic of the industry as a whole. "By
the end of 2000 there was a great deal of doom and gloom on the trading
floor about the impact of electronic trading," says Nicholas Neubauer. "Our
business model of open-outcry trading was being slated for early extinction
in favour of electronic matching engines." On top of this, he explains,
plans to become a for-profit organisation were seen as simplistic and caused
two lawsuits with the CBOE. In addition, the ceo of 20 years left. Having
set forth a programme of ten promises, including modifying the restructuring
plan, hiring a high quality ceo, and settling the law suits, Neubauer has
now put the exchange back on track.

Meanwhile, Ace, the electronic trading joint venture between CBoT and Eurex,
has been the subject of much wrangling over maintenance responsibilities.
However, the platform averages around 20,000 contracts a day, accounting for
roughly 230/0 of business. "Generally we have found that, on volatile days,
people use open-outcry and, on slow days, Ace increases its market share,"
explains Neubauer. "During volatile periods, traders get more information
out of a central marketplace than the more sterile environment of screen
trading." After the heartache that electronic trading and Ace in particular
caused, it was Ace's performance that fuelled the exchange's return to
profit in September.  Teething problems with new electronic trading systems
have been rife among many derivatives exchanges this year. As CBoT and Eurex
feuded over Ace, London Metal Exchange saw a lacklustre response to Select,
picking up slightly after a phase two launch in October, and New York
Mercantile Exchange argued with the providers of Enymex.

However, Liffe's Connect system has been the key to the revival of its
fortunes. After a few false starts, Connect has quickly gained acclaim for
its superior matching and distribution capabilities. Liffe won its first
major deal with Nasdaq to list futures on single stocks on Connect. Then, in
July, Liffe agreed to provide Connect products and services to Tokyo
Financial Futures and Options Exchange (Tiffe). In an alliance similar to
Ace, the Connect link allows Tiffe and Liffe members to trade on one
another's exchanges. It was Liffe's aptitude with derivative technology that
placed the company on a firm footing for November's merger. 

In October, CBOE launched CBOEdirect, to a modest reception. The system will
operate in pre-trade hours, initially with options on the Dow Jones
Industrial Index. CBOE's Provost explains that a feature of the system is
underscoring the world's altered preoccupations. "One benefit of beginning
to use screen-based trading is that it is a very logical and viable disaster
recovery trading system. This is something we, and other exchanges, are
looking at."

Of course, any retrospective on 2001 would not be complete without mention
of the World Trade Centre tragedy. During this terrible time, the financial
community came together with firm resolve, to help colleagues and
competitors alike, in an unprecedented show of solidarity. There was a
defiant determination to keep financial markets functioning as close to
normality as possible throughout the terrible ordeal, and in memory of those
who died.

**End of ISDA Press Report for December 28, 2001**

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Scott Marra 
Administrator for Policy and Media Relations
International Swaps and Derivatives Association 
600 Fifth Avenue 
Rockefeller Center - 27th floor 
New York, NY 10020 
Phone: (212) 332-2578 
Fax: (212) 332-1212 
Email: smarra@isda.org
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