Data released today by the BIS on positions in the global over-the-counter (OTC) derivatives market show continued market growth in the first half of 2000. The total estimated notional amount of outstanding OTC contracts stood at $94 trillion at end-June 2000, a 7% increase over end-December 1999 and a 30% increase since end-June 1998, when the BIS survey was initiated.(1) At the same time, the ratio of gross market values to notional amounts outstanding continued their downward trend.(2)
The statistics released today constitute the fifth set of semiannual series under a new regular reporting framework on OTC market activity. They cover the worldwide consolidated OTC derivatives exposures of major banks and dealers in the G10 countries.
Growth in the first half of 2000 was led by activity in forward-type contracts, particularly interest rate swaps, outright forwards and foreign exchange swaps. In terms of broad market risk categories, interest rate, foreign exchange and commodity contracts expanded at about the same pace, while equity contracts declined.(3) The overall buoyancy of activity in OTC derivatives markets contrasts with the stagnation of business conducted on derivatives exchanges (see Table 1), a trend already evident for much of the 1990s.
The new data also reveal a number of developments cutting across the different risk categories. For example, they show a continued rise in the share of euro-denominated transactions, particularly in interest rate swaps, where the euro has extended its lead as the largest currency segment. At the same time, the rate of expansion of yen-denominated contracts slowed down considerably relative to the previous review period. In addition, business with non-financial customers expanded fastest in all risk categories, although it remains much smaller than that conducted by reporting dealers and other financial sector entities (see Tables 2 and 3).
The interest rate segment expanded by 7%, to $64.1 trillion. With the stock of forward rate agreements (FRAs) and options stagnating, growth was concentrated in swaps (by 9%, to $48 trillion). Swaps have increased at a more robust pace than other interest rate instruments in recent years. This may have been related to the following factors. First, the growing variety of structures on offer has enabled the swaps market to respond in a more flexible way to the risk management requirements of market participants than exchange-traded markets. Secondly, the introduction of the euro has led to a rapid expansion of European capital market issuance, with some of the resulting exposure likely to have been hedged in the interest rate swaps market. Thirdly, net repayments or reduced net issuance of securities by central governments in some of the major reporting countries (with the notable exception of Japan) have affected the liquidity of government bond markets and the effectiveness of traditional hedging vehicles, such as government bond futures. This has encouraged market participants to switch to more effective hedging instruments, such as interest rate swaps. This shift seems to be confirmed by the stagnation of interest rate business on derivatives exchanges.
In the area of currency instruments, the value of contracts outstanding increased by 8%, to $15.5 trillion, following a slight decline in the previous reporting period. All types of instruments shared in the expansion, with outright forward and forex swap contracts rising most rapidly (by 9%), followed by currency swaps (7%) and options (3%). Some of the increase in outright forwards and forex swaps may have been related to the upsurge of activity seen in the international interbank market since the second half of 1999.(4) In the case of options, this was the first increase in business following four consecutive half-yearly declines. One of the most striking developments was the very sharp rise in currency contracts involving the euro (26%). The review period was marked by rising volatility of the dollar/euro currency pair, which may have fuelled related business. Contracts involving the US dollar and sterling also grew at a robust pace (by 9% and 11% respectively).
Activity in the equity-linked sector declined by 8%, to $1.7 trillion. Much of the drop was accounted for by contracts on US equities held by non-financial market participants. In spite of press reports highlighting the rapid growth of retail-targeted equity index products (which often combine fixed income assets and call options), the OTC equity-linked market has not expanded much in recent periods. It remains considerably smaller than the foreign exchange or interest rate market segments, being comparable in size to the exchange-traded equity index market ($1.5 trillion at end-June 2000).
Commodity derivatives markets expanded by 7%, to $0.6 trillion. The rate of expansion of gold contracts, the largest single group in that market segment, slowed considerably relative to the previous review period (to 8% from 29%).
Estimated gross market values declined by $232 billion, to $2.6 trillion. The ratio of gross market values to notional amounts outstanding fell to 2.7% at end-June 2000 from 3.2% at end-December 1999, maintaining the downward trend observed since the BIS began collecting OTC market data. Lower ratios were recorded in all market risk categories, with the exception of the commodity-linked segment, which saw an increase. The most pronounced decline took place in foreign exchange instruments (to 3.7% from 4.6%). Much of the reduction was accounted for by contracts involving the yen, which is consistent with the lower volatility of the underlying market during the review period. The decline was less substantial for interest rate instruments (to 1.9% from 2.2%) but was nevertheless notable in the euro segment (to 2% from 2.4%) and the yen sector (to 1.6% from 1.9%), probably also reflecting the lower volatility of underlying markets. It should be noted that gross market values exaggerate actual credit exposure since they exclude netting and other risk reducing arrangements. Allowing for netting, the derivatives-related credit exposure of reporting institutions was considerably smaller ($937 billion, or about 1% of notional amounts outstanding).
1 The notional amount, which is generally used as a reference to calculate cash flows under individual contracts, provides a comparison of market size between related cash and derivatives markets. The numbers are adjusted for double-counting resulting from positions between reporting institutions.
2 Gross market value is defined as the sum (in absolute terms) of the positive market value of all reporters' contracts and the negative market value of their contracts with non-reporters (as a proxy for the positive market value of non-reporters' positions). It measures the replacement cost of all outstanding contracts had they been settled on 30 June 2000.
3 Credit derivatives, which according to market sources have recently grown rapidly, are not identified in this survey. Data on such instruments will be collected at the time of the next triennial survey of foreign exchange and derivatives activity in June 2001.
4 See the section on the international banking market in the August 2000 issue of the BIS Quarterly Review.