TWN Info Service on Finance and Development (May16/03)
13 May 2016
Third World Network

Global OTC derivatives market falls to $493 trillion
Published in SUNS #8236 dated 9  May 2016

Geneva, 4 May (Kanaga Raja) - The global market for over-the-counter (OTC) derivatives saw a broad-based decline in activity in the second half of 2015, with the notional amount of outstanding contracts falling from $552 trillion to $493 trillion between end-June 2015 and end-December 2015, the Bank for International Settlements (BIS) has said.

In its latest statistics released on Wednesday (4 May), the Basel-based central bank for the world's central banks said that this represented a decline of 11%, with trade compression to eliminate redundant contracts being a key driver.

BIS further said that the fall in notional amounts was accompanied by a sharp drop in the gross market value of outstanding derivatives contracts, which provides a more meaningful measure of amounts at risk.

Gross market values decreased by 6% between end-June 2015 and end-December 2015, from $15.5 trillion to $14.5 trillion, their lowest level since 2007, and this decline was concentrated in interest rate swaps.

According to BIS, the overall size of the OTC derivatives market continued to contract in the second half of 2015. In US dollar terms, the notional amount of outstanding OTC derivatives contracts, which determines contractual payments and is one indicator of the total positions taken by market participants, fell by 11% between end-June 2015 and end-December 2015, from $552 trillion to $493 trillion.

Over this period, said BIS, exchange rate movements amplified the contraction of positions denominated in currencies other than the US dollar. "Yet, even after adjustment for this effect, notional amounts at end- December 2015 were still about 9% lower than at end-June 2015."

The gross market value of outstanding derivatives contracts - that is, the cost of replacing all outstanding contracts at market prices prevailing on the reporting date - fell again in the second half of 2015 - decreasing by 6% from $15.5 trillion at end-June 2015 to $14.5 trillion at end-December 2015, its lowest level since 2007.

Gross credit exposures remained at $2.9 trillion at end-December 2015, the same level as in the first half of 2015. This measure of counterparty credit risk represented 20% of gross market values at end-December 2015, a share that is slightly above the average observed since 2008 (16%).

On the interest rate segment, which accounts for the majority of OTC derivatives activity, BIS reported that at end-December 2015, the notional amount of outstanding interest rate derivatives contracts totalled $384 trillion, which represented 78% of the global OTC derivatives market. At $289 trillion, swaps accounted for by far the largest share of this market segment.

Notional amounts fell again sharply in the second half of 2015, primarily driven by a contraction in US dollar- denominated interest rate contracts. The notional value of US dollar contracts declined from $160 trillion to $139 trillion between end-June 2015 and end-December 2015. Contracts in euros decreased from $126 trillion to $118 trillion, while those in yen, sterling and other currencies also declined, said BIS.

Trade compression to eliminate redundant contracts was the major driver of the decline in notional amounts. The overall volume of compressions continued to grow in the second half of 2015, mainly reflecting the greater clearance of interest rate swaps and other contracts through central counterparties (CCPs), it added.

"Indeed, the distribution of interest rate derivatives by counterparty points to a continued shift in activity towards CCPs. Central clearing is a key element in global regulators' agenda for reforming OTC derivatives markets to reduce systemic risks," said BIS.

The notional amount of interest rate contracts between derivatives dealers, which had been falling more or less steadily since its peak of $189 trillion at end-June 2008, declined further during the second half of 2015 - from $61 trillion at end-June 2015 to $54 trillion at end-December 2015.

Contracts between dealers and other financial institutions, including CCPs, stood at $315 trillion at end- December 2015, down from $360 trillion at end-June 2015.

"This sharp decline is likely to have been accounted for by the move of trades to CCPs and related compression activity, which is facilitated by central clearing. Contracts with financial institutions other than dealers continued to account for the majority (82%) of interest rate derivatives contracts as of end-December 2015."

BIS said that the overall decline in notional amounts was not accompanied by a significant change in the maturity distribution of interest rate derivatives. As a share of all maturities outstanding, short-term contracts (with maturities of under one year) declined slightly, from 42% to 40%, between end-June 2015 and end-December 2015, while the percentage of long-term contracts (with maturities over five years) increased marginally, from 24% to 25%.

The gross market value of interest rate derivatives decreased from $11.1 trillion at end-June 2015 to $10.1 trillion at end-December 2015.

"This reflected the considerable decline in the notional amounts of outstanding contracts that took place during the same period. Increases in long-term yields are also likely to have contributed to the decrease in market values by narrowing the gap between market interest rates on the reporting date and rates prevailing at contract inception," said BIS.

On foreign exchange derivatives, which make up the second largest segment of the global OTC derivatives market, BIS reported that at end-December 2015, the notional amount of outstanding foreign exchange derivatives contracts totalled $70 trillion, which represented 14% of OTC derivatives activity. Contracts against the US dollar constituted 87% of this market segment.

After reaching its highest level for several years at end-December 2014, at $2.9 trillion, the gross market value of foreign exchange derivatives dropped during the first half of 2015 and then stabilised at around $2.5 trillion in the second half of the year. Contracts involving the US dollar increased from $2.2 trillion at end-June 2015 to $2.4 trillion at end-December 2015.

BIS said that the latest data show little change in the instrument composition of foreign exchange derivatives. Forwards and foreign exchange swaps jointly accounted for 52% of the notional amount outstanding. However, currency swaps represented the majority (52%) of the gross market value.

In contrast to the interest rate derivatives market, BIS said that inter-dealer contracts in the foreign exchange derivatives market continued to account for nearly as much activity as contracts with other financial institutions.

The notional amount of outstanding foreign exchange contracts between reporting dealers totalled $30 trillion at end-December 2015, and contracts with financial counterparties other than dealers at $31 trillion.

The inter-dealer share has averaged around 43% since 2011, up from less than 40% prior to 2011. Among instruments, inter-dealer activity accounts for a greater share of more complex contracts, such as currency swaps (54% of notional amounts) and options (46%).

According to BIS, the steady reduction in the size of the global credit default swap (CDS) market, which started in 2007, continued in the second half of 2015.

The notional amount of outstanding CDS contracts fell from $15 trillion at end-June 2015 to $12 trillion at end- December 2015, which represented only one fifth of its end-2007 peak of $58 trillion.

The market value of CDS also continued to decline, to, respectively, $421 billion at end-December 2015 in gross terms and $113 billion in net terms.

BIS said that the net measure takes account of bilateral netting agreements covering CDS contracts but, unlike gross credit exposures, is not adjusted for cross-product netting.

"The recent decline in overall CDS activity reflected mainly the contraction of the inter-dealer segment. The notional amount for contracts between reporting dealers fell from $6.5 trillion at end-June 2015 to $5.5 trillion at end-December 2015. Notional amounts with banks and securities firms also decreased in the second half of 2015, from $1.2 trillion to $0.9 trillion."

"Central clearing continued to make inroads," said BIS, adding that in line with the overall trend in OTC derivatives markets, notional amounts of CDS cleared through CCPs declined in absolute terms between end-June 2015 and end-December 2015, from $4.5 trillion to $4.2 trillion.

Nevertheless, the share of outstanding contracts cleared through CCPs has risen from less than 10% at mid-2010 (when data for CCPs were first reported separately) to 26% at end-2013 and 34% at end-December 2015.

"The latest data indicate that the trend towards netting may have stalled," said BIS, noting that until recently, the post-crisis shift towards central clearing had contributed to an increased use of legally enforceable bilateral netting agreements.

As a consequence, net market values as a percentage of gross market values had fallen from 26% at end-2011 to 21% at end-2013. This trend has since reversed, and the ratio actually rose to 27% at end-December 2015.

BIS further reported that the notional amount of OTC derivatives linked to equities totalled $7.1 trillion at end- December 2015, and the gross market value at $0.5 trillion.

"Derivatives linked to US equities, which had grown steadily over the past few years and in 2014 had overtaken those linked to European equities, decreased from $3.2 trillion at end-June 2015 to $2.8 trillion at end-December 2015. Derivatives linked to Japanese equities continued to decline, to $0.3 trillion at end-December 2015."

For OTC derivatives linked to commodity contracts, the latest data show no sign of a rebound from the sharp correction that occurred after the 2007-09 crisis, said BIS.

The notional amount of outstanding OTC commodity derivatives contracts declined from a peak of $13 trillion at end-June 2008 to $3 trillion at end-2009 and then $1.3 trillion at end-December 2015.

The gross market value of OTC commodity contracts stood at $0.3 trillion at end-December 2015, down from the mid-2008 peak of $2.2 trillion, it said.