TWN Info Service on Finance and Development (Nov18/01)
7 November 2018
Third World Network
  
Increased activity in global OTC derivatives market
Published in SUNS #8788 dated 5 November 2018

Geneva, 2 Nov (Kanaga Raja) - Activity in the over-the-counter (OTC) derivatives markets increased in the first half of 2018, with the notional amount of outstanding OTC derivatives contracts increasing from $532 trillion at end-2017 to $595 trillion at end-June 2018, the Bank for International Settlements ( BIS) has reported.

In its latest statistical release up to end-June 2018, BIS said that this increase in activity was driven largely by US dollar interest rate contracts, especially short-term contracts.

Nevertheless, the gross market value of outstanding derivatives contracts - which provides a more meaningful measure of amounts at risk - continued to decline, to $10 trillion, its lowest level since 2007, said BIS.

It attributed the decline in part to ongoing structural changes in OTC derivatives markets.

According to the Basel-based central bank for the world's central banks, gross credit exposures, which adjust gross market values for legally enforceable bilateral netting agreements, remained stable at $2.6 trillion at end-June 2018.

It said that the increase in notional amounts outstanding was driven mainly by OTC interest rate derivatives, in particular for US dollar-denominated contracts, which rose from $157 trillion at end-2017 to $193 trillion at end-June 2018.

An increase in US dollar activity was also seen in exchange-traded derivatives markets, where the average daily turnover of futures and options on dollar interest rates climbed to a record high of $9.6 trillion in the month of February.

"This increased activity may reflect changing expectations about the path of future US dollar interest rates during the period," said BIS.

The notional amounts outstanding of euro-denominated interest rate derivatives also went up over this period, but more modestly, from $122 trillion to $12 9 trillion.

BIS said that the increase in OTC interest rate derivatives activity was concentrated in the short-term segment.

The notional amount of outstanding contracts with a remaining maturity up to and including one year rose from $191 trillion to $231 trillion between end-201 7 and end-June 2018.

The increase for contracts with a remaining maturity between one and five years was less pronounced, from $140 trillion to $155 trillion.

On the other hand, longer-term contracts (with a remaining maturity over five years) held roughly constant, at around $94 trillion.

As for the OTC foreign exchange (FX) derivatives markets, BIS reported that notional amounts rose to a record high of $96 trillion at end-June 2018, up from $87 trillion at end-December 2017.

This was also driven by activity in short-term instruments, it said.

"In contrast to other OTC derivatives, most FX derivatives require counterparties to repay the notional amount at maturity and thus can be viewed as a form of collateralised borrowing, with the associated foreign currency repayment and liquidity risks."

GROSS VALUES OF OTC DERIVATIVES CONTINUES DECLINE

Despite the increase in notional amounts in the first half of 2018, the gross market values of outstanding OTC derivatives continued to decline, said BIS.

Gross market values for all OTC derivatives stood at $10.3 trillion at end- June 2018, down from $11.0 trillion at end-2017.

Over that same period, the gross market value of interest rate derivatives declined by $1 trillion, ending at $6.6 trillion.

Other segments of OTC derivatives markets saw smaller movements, with FX derivatives increasing from $2.3 trillion to $2.6 trillion and credit derivatives decreasing from $0.3 trillion to $0.2 trillion.

The continuing decline in gross market values reflected in part ongoing structural changes in OTC derivatives markets, said BIS.

These changes include central clearing and greater possibilities for trade compression - that is, the elimination of economically redundant derivative s positions.

In addition, in recent periods an increasing number of banks have been recording variation margin on cleared derivatives as settlement payments rather than as transfers of collateral.

BIS explained that the practice of so-called settled-to-market (STM) allows counterparties to take ownership of the collateral that they receive. Consequently, daily payments of variation margin are recorded as settlements of the derivatives transactions rather than as transfers of collateral and the market value of the derivatives is reset daily to zero.

STM, which is increasingly adopted for cleared swaps in particular, thus results in lower market values for a given derivative, it said.

CREDIT DEFAULT SWAP MARKET

According to BIS, notional amounts of credit default swaps (CDS) continued to decline, owing to decreased activity between reporting dealers.

From end-June 2016 to end-June 2018, total notional amounts dropped from $1 2 trillion to $8 trillion, amounts vis-a-vis reporting dealers declined from $5 trillion to $2 trillion, and amounts vis-a-vis central counterparties (CCPs) remained steady around $4.5 trillion.

In the first half of 2018, the share of notional amounts cleared with CCPs was stable at 54%, in contrast to the upward trend over the past few years.

In OTC interest rate derivatives markets, the proportion of contracts cleared was also steady in the first half of 2018, at around 76% overall, while in the OTC FX derivatives markets, clearing accounted for only 3.0% of dealers' outstanding contracts at end-June 2018, said BIS.