A planned exchange for the trading of derivatives in the UAE will need new legislation to ensure adequate regulation of the industry, the head of Abu Dhabi's stock market said.
Derivatives inspire about as much fear and anxiety among financial firms and regulators as they do giddy conversations of the growth potential of an industry that is approaching a quadrillion dollars in size and growing fast.
The global financial crisis has forced years of reflection by regulators on how best to oversee the potentially combustible industry.
The proposed Gulf Derivatives Exchange would require many new laws, rules and regulations, and even systems, said Rashed Al Baloushi, the chief executive of the Abu Dhabi Securities Exchange (ADX).
The most important thing the industry needs is "awareness and awareness and awareness", he said.
The most advanced plans would have enabled cash derivatives for listed companies - for the most part blue-chips with liquid stocks, Mr Al Baloushi said.
The ADX is testing the waters with the industry, and met with representatives of custodian firms this month at an event hosted by Standard Chartered in Dubai and attended by representatives of the National Bank of Abu Dhabi, HSBC, Citi and Deutsche Bank and other firms.
Data from the Bank for International Settlements, the association of global central banks, show futures and options contracts tracking assets worth US$470.4 trillion were traded on exchanges in the first quarter of this year, with a further $24.7tn traded "over the counter" or directly between banks.
Credit derivatives are widely regarded to have been the factor that turned trouble in the subprime mortgage market into a full-scale financial meltdown.
Abu Dhabi Commercial Bank, Dubai's Mashreqbank and Kuwait's National Industries Group lost hundreds of millions of dollars through soured investments.
Many of these losses occurred through collateralised debt obligations and structured investment vehicles, which raised debt to buy up bundles of junk-rated bonds that were given the highest investment grades by ratings agencies.
But banks are seeking to bolster the importance of derivatives to the UAE financial industry as Dubai and Abu Dhabi seek to develop their financial services industries.
"This could potentially be big business," said Philippe Carre, the global head of connectivity for SunGard's capital markets business.
"This could also bring to the UAE a new population of trading firms that specialise in this area, and naturally provide new opportunities to local players."
Michael Tomalin, who retires as chief executive of the National Bank of Abu Dhabi this month, called for the UAE to develop itself as a "netting" jurisdiction, a process that allows banks to calculate capital requirements based on gross exposures, which can be many multiples higher if they have several long and short contracts to the same counterparty.
To allow netting, the UAE would have to revise its creditor-unfriendly bankruptcy laws. Hiring of skilled derivatives operators has been slower than other business lines, though some have made intermittent recruitments recently, recruiters said.
"I wouldn't say it's a buoyant market," said Giles Blundell, a partner at the recruitment firm The GCC Partners. "But there's a handful of bigger banks that have a reasonable business, and top banks do well out of it."
However, the increasing numbers of local banks entering derivatives markets was putting pressure on the handful of smaller investment firms that are unable to package them with loans or other products.
"We think it's a very crowded market," said Michael Raynes,the chief operating officer of Waha Capital.
"International banks can leverage their balance sheet, and local banks have become much better over the last five years at leveraging lending relationships to clients."
The firm structures fixed-income derivatives for hedging credit risk, but ignores derivatives on the sell side for that reason.