TWN Info Service on Finance and Development (May17/03)
22 May 2017
Third World Network

Global OTC derivatives market falls to $483 trillion
Published in SUNS #8464 dated 17 May 2017

Geneva, 16 May (Kanaga Raja) -- The global market for over-the-counter (OTC) derivatives saw a decline in the second half of 2016, with the notional amount of outstanding contracts (which determines contractual payments) falling from $553 trillion to $483 trillion between end-June and end-December 2016, the Bank for International Settlements (BIS) has reported.

In its latest statistics for OTC derivatives for the six months ending in December 2016, BIS said this decline in the second half of 2016 was a reversal of the trend witnessed in the first half of that year which saw an increase in outstanding OTC derivatives positions.

According to BIS, the central bank for the world's central banks, the gross market value of the outstanding OTC derivatives contracts, that is, the cost of replacing all these contracts at current market prices, fell from $21 trillion to $15 trillion over the same period.

Gross credit exposures, which adjust gross market values for legally enforceable bilateral netting agreements, fell from $3.7 trillion to $3.3 trillion during the same period.

However, as a share of gross market values, gross credit exposures rose from 17% to 22%.

BIS noted that central clearing, which is a key element in authorities' agenda for reforming the OTC derivatives markets to reduce systemic risks, made further inroads in OTC derivatives markets in the second half of 2016.

In OTC interest rate derivatives markets, the share of reporting dealers' positions booked against central counter-parties (CCPs) stood at 76% at end-December 2016, similar to the share observed six months earlier.

Among interest rate instruments, the share of notional amounts booked against CCPs was highest for forward rate agreements, at 92%, followed by interest rate swaps, at 81%.

In contrast, the share remained negligible for interest rate options, despite a quadrupling of the outstanding amount of options contracts reported against CCPs in the second half of 2016, from $53 billion to $225 billion.

The share of outstanding credit default swaps (CDS) cleared through CCPs jumped from 37% at end-June 2016 to 44% at end-December 2016.

According to BIS, this jump represented the largest semi-annual increase since CCP data for CDS were first collected in 2010.

The proportion of contracts centrally cleared increased for single-name as well as multi-name instruments, although it remained much higher for the latter (54%) than for the former (36%).

In OTC foreign exchange (FX) derivatives markets, BIS said while only 1% of notional amounts were centrally cleared at end-December 2016, the outstanding amount cleared almost tripled in the second half of 2016, from $352 billion to $903 billion.

"The rising importance of central clearing in OTC derivatives markets is consistent with the incentives provided by higher capital and margin requirements for non-centrally cleared derivatives."

Regulators in most of the major derivatives markets require certain classes of standardised OTC derivatives, particularly interest rate swaps and CDS, to be centrally cleared.

BIS said while options, FX derivatives and equity derivatives are generally not covered by these requirements, higher margin requirements for non-centrally cleared derivatives are being phased in, starting in Canada, Japan and the United States in September 2016 and in other key markets in 2017.

BIS reported that notional amounts of OTC interest rate derivatives fell to $368 trillion at end-December 2016, their lowest level since 2007.

Contracts denominated in euros, sterling, Swedish kronor and yen fell especially sharply in the second half of 2016, owing in part to the depreciation of these currencies against the US dollar.

The gross market value of interest rate derivatives also declined, falling from $15.5 trillion at end-June 2016 to $10.0 trillion at end-December 2016.

"This decline is likely to have reflected the fall in notional amounts during the period as well as increases in long-term yields, which reduced the gap between market interest rates on the reporting date and rates prevailing at contract inception."

Interest rate swaps are the single largest segment in OTC derivatives markets, said BIS.

It noted that at end-December 2016, they accounted for 57% of the notional amount of all outstanding OTC derivatives and 59% of the total gross market value.

"Yet their importance has been declining since 2014, when they accounted for close to 70% of the gross market value of all OTC derivatives. Trade compression to eliminate redundant contracts has been a major factor. Compression was aided by the shift towards CCPs, which in effect multilateralised the compression process."

The notional amount of outstanding FX derivatives stood at $68.6 trillion at end-December 2016, in line with levels observed since 2013. Their gross market value totalled $3.0 trillion, which was close to the high of $3.1 trillion reported at end-June 2016.

Notwithstanding the stable overall trend, the gross market value of contracts involving the pound sterling almost halved in the second half of 2016, from $624 billion to $338 billion.

"This reversed the spike seen at end-June 2016, which occurred on the back of the sharp depreciation of the currency following the Brexit referendum," said BIS.

The notional amount of outstanding FX contracts between reporting dealers totalled $30.3 trillion at end-2016, which represented 44% of all FX contracts outstanding.

Contracts with financial counter-parties other than dealers and CCPs equalled $28.9 trillion, while those with non-financial customers stood at $8.4 trillion. Contracts with CCPs totalled only $0.9 trillion, said BIS.

The notional amount of outstanding CDS contracts dropped substantially in the second half of 2016, from $11.8 trillion to $9.9 trillion, continuing the downward trend observed since 2008.

The gross market value of CDS also fell further, to $292 billion. The latest decline in overall CDS positions was concentrated in the uncleared segment, said BIS.

Whereas the notional amount cleared through CCPs was more or less unchanged in the second half of 2016, at $4.3 trillion, the notional amount for contracts between reporting dealers fell from $5.1 trillion to $3.7 trillion.

"Higher margin requirements for non-centrally cleared derivatives are likely to have been an important factor contributing to this contraction."

Net market values, which adjust gross market values for netting agreements among CDS counter-parties, totalled $79 billion at end-December 2016, equivalent to 27% of gross market values.

The prevalence of netting is greatest for CDS contracts with other reporting dealers and CCPs, for which net market values as a percentage of gross values equalled 22% and 15%, respectively, at end-December 2016.

BIS said netting is least prevalent for contracts with insurance companies and non-financial customers, with the comparable ratios for both of those groups standing at 71%. +