The global OTC derivatives market at end-December 1999
18 May 2000
The BIS is releasing today its semiannual statistics on positions in the global over-the-counter (OTC) derivatives market for end-December 1999. These statistics constitute the fourth set of data released under a new regular reporting framework on OTC market activity. They include the notional amounts and gross market values outstanding of the worldwide consolidated OTC derivatives exposure of major banks and dealers in the G10 countries (see attached tables)(1)
After adjustment for double-counting resulting from positions between reporting institutions, the total estimated notional amount of outstanding OTC contracts stood at $88.2 trillion at end-December 1999, an 8% increase over the $81.5 trillion reported for end-June 1999. This represents a significant acceleration relative to the first half of 1999, when business had expanded by a mere 1% from the previous half-year. Similar growth patterns have been reported by other surveys of OTC market activity(2)
The return to growth of the OTC market was essentially concentrated in the interest rate segment, with an increase in outstanding contracts of 11% over the previous half-year period (to $60.1 trillion). By contrast, there was a further contraction of foreign exchange instruments, which declined by 4% (to $14.3 trillion). The reduction of activity in this segment had been particularly pronounced in the first half of last year (17%), in the wake of the introduction of the single European currency. The much smaller equity-linked and commodity segments expanded the most rapidly of all underlying risk categories, with increases of 20% and 24% respectively (to $1.8 trillion and $0.5 trillion).
While the acceleration of activity in the interest rate compartment was fastest in the swap markets (15% to $43.9 billion), the expansion of business in the option market was fairly sustained (10% to $9.4 trillion). The forward rate agreement market, which had experienced a sharp increase in the first half of 1999, contracted (by 5% to $6.8 billion). Thus the reduced rate of growth seen in the first half of 1999 can be attributed to this unwinding having run its course. However, it also reflected the introduction of the euro. The expansion of euro zone instruments slowed sharply relative to the previous reporting period (to 6% from 21%) as the introduction of the single currency eliminated interest rate arbitrage activity between the various legacy currency segments. Of note, business in the US dollar returned to rapid growth (to 17% from 4%). The reduced presence of leveraged funds appears to account for a redistribution of activity among counterparties back towards the group of reporting dealers (50%).
The most recent data on the OTC interest rate market confirmed the rapid development of non-dollar instruments. Indeed, while euro- and yen-denominated contracts accounted for the bulk of market expansion, the increase in dollar business was marginal. This enabled the euro-denominated sector to increase in size and reinforce its lead over the US dollar segment (34% of outstandings versus 27%). The lethargic pace of activity in the latter segment is somewhat difficult to reconcile with reports of growing use of interest rate swaps as hedging and positioning alternatives to US Treasury securities, and of brisk millennium-related activity. The withdrawal of certain US-based financial institutions since the crisis in the second half of 1998, the paring down of market-making capital by some institutions and/or the adoption of more conservative risk management policies might have reduced market liquidity and, therefore, hampered business. The data for the second half-year also show that the swap market remains the preserve of financial institutions. Such entities (both reporting dealers and other financial institutions) accounted for all of the increase in activity in the second half of 1999 and for 91% of outstanding contracts. Positions involving non-financial customers increased marginally. In fact, in spite of the buoyancy of capital market activity, such users have barely increased their recourse to the swap market since the BIS began its survey of OTC markets.
In the area of currency instruments, the stock of outright forward and forex swap contracts was stable following the sharp drop resulting from euro-related consolidation in the previous period. This was not the case with the stock of currency options, which declined for the fourth consecutive half-year period. Meanwhile, business in currency swaps continued to exhibit a steady upward trend. A look at the currency breakdown for all types of foreign exchange positions reveals that activity moderated in contracts involving the three major world currencies, with the most pronounced decline being in yen contracts. Although the review period was marked by rising currency volatility, which could have been expected to fuel turnover, the steady strengthening of the yen against the two other major currencies might have led to a drying-up of some option products involving the yen, such as barrier options(3) Moreover, the lower level of activity in currency derivatives might also have been the result of subdued business in the underlying markets. Informal estimates by market participants suggest that there has been a sizeable decline in foreign exchange turnover in the major centres since autumn 1998(4) As in the market for interest rate products, the share accounted for by financial institutions rose further.
The equity-linked sector revived in the second half of last year, with growth in outstandings of 20% (to $1.8 trillion). Business is likely to have been fuelled by the very strong performance of global equity markets during the review period. The most striking development in this market sector was the particularly pronounced increase in business with non-financial customers.
Commodity derivatives markets were also highly active, with outstandings rising by 24% (to $548 billion). Transactions involving gold, the largest single component of the commodity derivatives market, were particularly buoyant. The review period was eventful for the broader gold market. The metal’s price, which had followed a downward trend for much of the year, rose sharply in late September following an agreement among central banks limiting official gold sales over the next five years.
Estimated gross market values in the second half of 1999 rose by 7% (to $2.8 trillion) but their share of reported notional amounts remained stable at 3%. Such 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 much smaller ($1 trillion).
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. 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 31 December 1999. The use of notional amounts and gross market values produces widely divergent estimates of the size of the overall market and of the various market segments.
2 For example, data released by the International Swaps and Derivatives Association show that the outstanding stock of interest rate swaps, currency swaps and interest rate options grew by 11% in the second half of 1999. This was appreciably faster than in the first half of the year, when business had expanded by only 3%. Quarterly data published by the US Office of the Comptroller of the Currency on holdings of derivatives by US banks (largely OTC contracts) also showed more rapid growth in the second half of 1999, to 5% from zero growth in the first half.
3 A barrier option is an option for which the payoff pattern and survival to expiration depend not only on the final price of the underlying but also on whether the underlying will reach or go through a set price (barrier) during the life of the option.
4 See "A look at trading volumes in the euro", BIS Quarterly Review, February 2000, pp. 33-35.