The Hindu Business Line : ‘OTC derivatives market sees steady growth in H2 of 2007’

The notional amounts of all categories of OTC contracts rose by 15% to $596 trillion at the end of December 2007, following a 24% increase in the first half of that year.

K.R. Srivats

New Delhi, May 22 The over-the-counter (OTC) derivatives market ha’s shown relatively steady growth in the second half of 2007 despite the sub prime crisis-spawned turmoil in global financial markets, according to the Bank for International Settlements (BIS).

In its report released on Thursday in Basle (Switzerland) on OTC derivative market activity in the second half of 2007, the central bankers’ central bank, BIS said that the notional amounts of all categories of OTC contracts rose by 15 per cent to $596 trillion at the end of December 2007, following a 24 per cent increase in the first half of that year.

Growth remained particularly strong in the credit segment, where the notional amounts of outstanding credit default swaps (CDS) increased by 36 per cent to $58 trillion. The 36 per cent expansion in CDS in the second half of 2007 is, however, slower than the 49 per cent recorded in the first half of that year.

Credit swaps

CDS are swaps designed to transfer the credit exposure of fixed income products between parties. The buyer of a credit swap receives credit protection and the seller of the swap gives assurance on the credit worthiness of the product. By this, the risk of default is transferred to the seller of the CDS from the holder of the fixed income security.

For example, a buyer of CDS will be entitled to the par value of a bond by the seller of the swap should the bond default in the credit payments.

The BIS report showed that gross market values, which measure the cost of replacing all existing contracts, increased by 30 per cent and reached $15 trillion in total at the end of December 2007. In particular, gross market values of CDS almost tripled (an increase of 178 per cent) to $2 trillion, due chiefly to a substantial price movement of CDS contracts during the period. An increase in gross market values was found in all categories of OTC contracts.

Interest derivatives

In the second half of 2007, there was moderate growth in interest derivatives and subdued activity in equity derivatives. The rapid expansion in the notional amounts and gross market values of OTC interest rate derivatives in the first half of 2007 (19 per cent and 26 per cent respectively) gave way to more moderate growth (13 per cent and 18 per cent) in the second half of the year. Notional amounts outstanding and gross market values stood at $393 trillion and $7.2 trillion respectively at the end of December 2007.

However, the growth in notional amounts of OTC equity derivatives slowed markedly from 15 per cent in the first half of 2007 to -1 per cent in the second, the first negative growth rate since the second half of 2004. The notional amounts of OTC equity contracts stood at $8.5 trillion at the end of December 2007.

The gross market value of OTC equity contracts had increased slightly by 2 per cent to $1.1 trillion at the end of December. Meanwhile, the market for OTC commodity derivatives showed robust activity, with notional amounts increasing by 19 per cent in the second half of 2007 to reach $9 trillion at the end of December.