TWN Info Service on Finance and Development (Nov08/06)
22 November 2008
Third World Network

Finance: Global market for OTC derivatives reaches $683.7 trillion
Published in SUNS #6591 dated 17 November 2008

Geneva, 14 Nov (Kanaga Raja) -- Trade in the opaque, over-the-counter (OTC) derivates has continued to expand - despite the financial crisis, traced by everyone to the derivatives trade and the toxic assets generated by them.

According to the latest report from the Bank for International Settlements (BIS), the notional amounts outstanding of over-the-counter (OTC) derivatives continued to expand in the first half of 2008, with all types of OTC contracts standing at $683.7 trillion at the end of June.

The BIS has said that its next OTC derivatives statistics covering the second half of 2008 will be released no later than 29 May 2009.

In releasing Thursday, its latest available statistics on positions in the global OTC derivatives market at end-June, the Basel-based bank for the central banks said that the $683.7 trillion value of outstanding contracts represented an increase of
15% from six months before.

The Gross Market Values, which measure the cost of replacing all existing contracts and are thus a better gauge of market risk than notional amounts, increased by 29% to $20.4 trillion at the end of June 2008.

The statistics complied by BIS cover the notional amounts and gross market values outstanding of the worldwide consolidated OTC derivatives exposure of major banks and dealers in the G10 countries.

(The financial crisis that originated in the United States sometime last year has been sourced in part to the global derivatives trade. The increase in the notional amounts in the global derivatives trade cited by BIS appears to highlight in part the activities of traders in taking advantage to maximize on their profits in a highly volatile market. But for the public at large, and the real economy hit by such speculative activities, these continued activities of traders to maximise their individual profits, without regulatory authorities stepping in, may be very disquieting, and create political forces to rein in the OTC trades. The hedge fund industry has also come under the spotlight recently when a US Congressional Committee this week debated whether the industry needed to be regulated.)

(Derivatives are financial instruments whose prices are derived from the value of stocks, bonds, commodities, currencies, interest rates and even stock market indices. They are normally used to hedge against risk but can also be used for speculative purposes, and essentially to evade or get around regulatory restrictions.)

In its latest statistics, the BIS noted that multilateral terminations of outstanding contracts resulted in the first ever decline of 1% in the volume of outstanding credit default swaps (CDS) since the first publication of CDS statistics in December 2004.

The average growth rate for outstanding CDS contracts over the last three years has been 45%. In contrast to CDS markets, markets for interest rate derivatives and FX (foreign exchange) derivatives both recorded significant growth. Open positions in interest rate derivatives contracts rose by 17%, while those in FX contracts expanded by 12%.

According to BIS, for the first period ever since publication of the statistics began in December 2004, the notional amounts outstanding of CDS contracts saw a decline of 1% compared with the notional amounts outstanding at the end of 2007. Despite the decline in outstanding volumes, the gross market value for CDS contracts increased by 58%. Gross market values rose for both single- and multi-name contracts.

While single-name CDS contracts grew by 3% to $33.3 trillion, the outstanding volume of multi-name CDS contracts, a category that includes CDS indices and CDS index tranches, declined for the first time since publication began in December 2004. The outstanding amount of multi-name CDS contracts decreased by 6.5% to $24.0 trillion in the first half of 2008.

BIS said that the decline to a large extent reflected early agreed terminations or netting of outstanding CDS contracts. Multilateral terminations have had a substantial effect on the size of the CDS market in recent years. This trend continued with increased strength in the first half of 2008, when contracts totalling $17.4 trillion were terminated, mainly in the multi-name segment. This reduced the rate of increase in the outstanding amounts by nearly 30 percentage points.

BIS highlighted significant growth in interest rate products. It said that growth in the notional amounts outstanding of OTC interest rate derivatives increased in the first half of 2008 after an average rate of increase in the second half of 2007. Notional amounts outstanding of these instruments reached $458.3 trillion at the end of June 2008, 17% higher than six months previously.

Gross market values of OTC interest rate derivatives grew by 29% to $9.3 trillion, driven primarily by interest rate swaps, which constitute by far the largest market segment.

The notional amounts outstanding of interest rate swaps increased by 15% to $356.8 trillion, while the gross market value of these swaps rose by 30% to $8.1 trillion in the first half of 2008. Outstanding volumes of option contracts expanded by a moderate 9% to $62.2 trillion, while gross market values went up by 17% to $1.1 trillion.

In contrast to the moderate growth in options, said the Basel-based bank, there was very high growth in both the outstanding amounts and gross market values of forward rate agreements (FRAs). The money market turmoil in the period resulted in a 48% increase in the outstanding volume of FRAs to $39.4 trillion, while their gross market value rose by 114% to $88 billion in the period.

The rapid growth in outstanding FRAs was visible for all major currencies except the Australian dollar, where growth was concentrated in options (98%) and interest rate swaps (53%).

While growth remained strong in all currencies, positions in Australian dollars (50%), sterling (36%) and Swiss francs (28%) increased at notably higher rates than those in euro- and dollar-denominated contracts (18% and 15%, respectively).

However, at $2.5 trillion, $38.6 trillion and $5.2 trillion, respectively, the Australian dollar, sterling and Swiss franc segments remained considerably smaller than those of the euro and the US dollar ($171.9 trillion and $149.8 trillion, respectively).

The BIS report also observed robust activity in foreign exchange derivatives. Notional amounts of foreign exchange derivatives increased by 12% to $63.0 trillion, while gross market values rose by 25% to $2.3 trillion. Growth in the notional amounts of FX options and currency swaps (15% and 14%, respectively) outpaced the change in overall volumes.

Forwards, which account for roughly half of total OTC FX derivatives when measured in terms of notional amounts, grew slightly less than the market total.

BIS noted no significant changes in the currency composition of FX derivatives. The dollar remained the most important vehicle currency, well ahead of the euro. Eighty-three per cent of all contracts (measured by notional amounts) had one leg denominated in US dollars, compared to 41% for the euro and 22% for the yen.

As to equity derivatives, BIS reported that notional amounts outstanding of OTC equity derivatives increased by 20% in the first half of 2008, reversing a 1% decline in the second half of 2007. Notional amounts of OTC equity contracts stood at $10.2 trillion at the end of June 2008, more than half of which was accounted for by contracts written on European stocks.

The OTC equity derivatives market is dominated by options, which account for around three quarters of all contracts in terms of notional amounts and gross market values. Growth in outstanding positions in equity derivatives was more pronounced for the medium- and longer-term maturities, which grew by 31% and 18%, respectively.

The market for OTC commodity derivatives showed robust activity, with notional amounts increasing by 56% in the first half of 2008 to reach $13 trillion at the end of June, said BIS, adding that this was largely due to strong growth in non-gold contracts (which increased to $12.6 trillion).

It found that forwards and swaps in these contracts increased by 49% to $7.6 trillion, and option volume by 81% to $5 trillion. Growth in gold contracts slowed to 9% (after rising by 40% in the second half of 2007). Gross market values of commodity contracts in total increased by 16% to $2.2 trillion.