Is the OTC derivatives market larger or smaller than 5 years ago? How much progress has the industry made in central clearing? By how much does netting reduce credit exposures?
If these and questions like them are of interest, have a look at the latest edition of ISDA’s Market Analysis. The paper integrates market data from a variety of sources – the BIS, clearinghouses and ISDA itself, to name a few – to show the impact of clearing, netting, compression and collateral on notional amounts and risk exposures in the over-the-counter (OTC) derivatives markets.
Take the first question above: the size of the OTC derivatives markets. If you look at notional amounts published by the BIS, you can see the size of the market increased by about 11% over the past five years. On an adjusted basis, however, the market declined by 9%.
What accounts for the difference? Two things. First, our analysis eliminates double-counting of cleared swaps. Clearing increases volumes (as one swap between counterparties is transformed into two swaps between each counterparty and the clearinghouse), even as it is designed to reduce risk. It’s worth noting that the cleared volume of interest rate swaps totaled 53.5% of IRS outstanding at year-end. That’s the highest percentage yet and it’s a 151% increase over year-end 2007. Second, our analysis also excludes FX transactions (as they are in many ways unlike other OTC derivatives).
So on an adjusted basis, the market has declined. Why? One of the key factors is compression. Over the past decade or so, compression has reduced notionals outstanding by a little over $200 trillion, including some $120 trillion in interest rate derivatives and $80 trillion in credit default swaps. Compression is clearly one of the biggest factors driving changes in the volume of derivatives outstanding.
So far we’ve talked about notionals, which measure activity but not risk. Gross market value (GMV) reflects that risk by measuring the cost of replacing contracts. As the BIS reported, GMV increased for the period ending December 31, 2011 from mid-year 2011. Netting (a subject close to ISDA’s heart given our role in ensuring it helps firms reduce risk) lowers credit exposure to 14.3% of GMV and 0.6% of notionals. Collateralizaton reduces credit exposures to an even lower level.
We think these statistics tell an interesting story, even if it is not the tale that is often told. But that’s why we started the Market Analysis in the first place. We hope it leads to a more informed view of the key trends shaping the global OTC derivatives market.
For further insight, listen to yesterday’s derivatiViews post, a short interview with ISDA CEO Bob Pickel about the Market Analysis.