The Hindu Business Line : Derivatives market expands in first half: BIS report

New Delhi, Nov. 15 The Bank for International Settlements (BIS) has said the notional amounts outstanding of over-the-counter (OTC) derivatives continued to expand in the first half of 2008 and stood at $683.7 trillion at the end of June.

In its semi-annual publication of market developments of OTC derivatives, interest rate derivatives and foreign exchange (FX) derivatives released at its headquarters in Basle recently, the central bankers’ central bank said multilateral terminations of outstanding contracts resulted in the first-ever decline of one per cent in the volume of outstanding credit default swaps (CDS) since the first publication of CDS statistics in December 2004.

This small decline needs to be seen against the average growth rate for outstanding CDS contracts over the last three years which has been 45 per cent. CDS allow an investor to buy insurance against a company defaulting on its debt payments.

A salutary concept

Market analysts said when it was originally introduced, the CDS was a salutary concept because more people felt cosy owning corporate debt if they could do away with the risk of issuer failing. The additional appetite for debt enabled lowering the cost of capital.

In contrast to CDS markets, markets for interest rate derivatives and FX derivatives both logged significant growth. Open positions in interest rate derivatives contracts rose by 17 per cent, while those in FX contracts expanded by 12 per cent. Gross market values, which measure the cost of replacing all existing contracts and are thus a better gauge of market risk than notional amounts, rose by 29 per cent to $20.4 trillion at the end of June 2008.

BIS said growth in the notional amounts outstanding of OTC interest rate derivatives increased in the first half of 2008 after an average 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 per cent higher than six months previously. Gross market values of OTC interest rate derivatives grew by 29 per cent to $9.3 trillion, driven primarily by interest swaps, which constitute by far the largest market segment.

The notional amounts of outstanding interest rate swaps increased by 15 per cent to $356.8 trillion, while the gross market value of these swaps rose by 30 per cent to $8.1 trillion in the first half of 2008.

BIS said that in contrast to the moderate growth in options, 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 per cent spurt in the outstanding volume of FRAs to $39.4 trillion, while their gross market value rose by 114 per cent to $88 billion in the period.

Forex derivatives

Referring to FX derivatives, BIS said notional amounts of such derivatives rose by 12 per cent to $63 trillion, while gross market values rose by 25 per cent to $2.3 trillion. Stating that there were no significant changes in the currency composition of FX derivatives, BIS said the US dollar remained the most important vehicle currency, well ahead of the euro. It said 83 per cent of all contracts (measured by notional amounts) had one leg denominated in US dollars, compared to 41 per cent for r the euro and 22 per cent for the yen.

Notional amounts outstanding of OTC equity derivatives increased by 20 per cent in the first half of 2008, reversing a one per cent decline in the second half of 2007 and stood at $10.2 trillion at the end of June, more than half of which was accounted for by contracts written on European stocks.

Equity derivatives

The OTC equity derivatives market is led 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.

Finally, BIS said the market for OTC commodity derivatives showed ‘robust activity’, with notional amounts increasing by a hefty 56 per cent in the first half of 2008 to reach $13 trillion at the end of June 2008.

This was largely due to strong growth in non-gold contracts (which increased to $12.6 trillion). Forwards and swaps in these contracts increased by 49 per cent to $7.6 trillion and option volume by 81 per cent to $5 trillion. Growth in gold contracts slowed to 9 per cent, after rising by 40per cent in the second half of 2007. Gross market values of commodity contracts in total increased by 16 per cent to $2.2 trillion.

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