Equity v credit derivatives showdown: Difference between revisions

Nominally just derivatives attaching to a different part of the capital structure but don't be fooled. Almost everything about them is different.

The equity derivative is an age-old family if products that ISDA simply codified: [[put]]s, [[call]]s, [[collar]]s — options, basically — and [[contracts for difference]] on shares and baskets of shares. The {{eqdefs}}, published in 2002, pulled in share indices, but these are really just complicated, large baskets. While not perfect, the equity definitions do a serviceable enough job of describing what is essentially a straightforward product, though they get a bit gummed up about dividends, and tax can get complicated. The product traded is for the most part a [[delta-one]] exposure to shares, share baskets and indices and, while hedging can be fraught in times of market dislocation, and hedging costs get passed through to end users, the basic notional value of an equity derivative is not: the market price of a listed share: you can see it printed in 6 point font in the Financial Times every day.

Credit derivatives specialists who come to the equity derivatives, as droves did after the collapse of the structured credit derivative market in 2008 tend to be quite surprised and alarmed at the simplicity of equity derivatives. They are just not that fiddly. The decade following the crisis the basic synthetic equity product did become ''more'' fiddly, but a lot of that was refugee structured credit lawyers not knowing what they were doing.

To be clear: the equity product is ''structurally'' simple; you can just as easily lose your shirt, as [[Archegos]]’ [[prime broker]]s would tell you.

As the saying goes, “if it ain’t broke, don’t fix it” and the market has remained loyal to the {{eqdefs}} despite a noble attempt by [[Flight 19]], a routine mission of Linklaters complexity bombers, to overhaul them in 2011 which failed rather epically. We have quite a bit of fun at their expense in these pages. As far as we know not a single trade has ever been documented under the [[2011 Equity Derivatives Definitions]]. If you happen to know of one, please ''don’t'' write in to tell us: that would spoil an impression of outright calamity we are quite happy labouring under.

Their original abstract intellectual purity has long since evaporated,  brutalised by repeated, savage, real-world market dislocations. They are now a fearful, paranoid, jabbering wreck of gabbling cabbage. It is as if the winsome fever dream of some JP Morgan brainboxes, strained through the gusset of the [[First Men]] and then wrung out with some [[Potts Opinion|QC opinions]] has taken root, allowed to flourish, run wildly out of control, threatened life as we know it and then been mercilessly beaten, bent, twisted and hacked at by a community of embittered banking regulators, themselves branded by the white-hot iron of civilisation-threatening financial disaster.  

{{Eqderiv}} are means of gaining exposure — positive or negative — to an instrument without owning it. The basic point of the contract is to replicate exactly the economic features of the [[Underlying|underlier]], minus the physical, reporting, funding and — maybe? — tax@@ aspects of being on the register. You buy or sell an {{eqderiv}} ''instead of'' buying or selling the [[Underlying|underlier]].

So oddly, while you would expect equities to be about corporate default and credit derivatives to be about relative performance in the absence of default, it is the other way round. Credit derivatives, like Bonds, tend to have a fixed term and a fixed premium and, while you can mutually terminate them at market price, there is no ''right'' to do so in the absence of a catastrophic failure — any exit is negotiated and dependent on prevailing liquidity. Equity swaps tend not to have a tenor (they may ''have'' one, but it doesn’t ''mean'' anything) and to be terminable on the client side at any time.