Global OTC derivatives trading volumes have slipped as market participants adjust to impending regulation and the emergence of swap futures, new data has shown.
The Bank for International Settlements’ (BIS) semi-annual OTC derivatives report, released yesterday, examines the industry from June to December 2012 and showed an overall drop in notional outstanding of US$6 trillion to US$633 trillion. The decline follows a 1% drop from January to June 2012.
Credit default swaps (CDSs) are one instrument that has shown a marked decline. The BIS report showed the total notional outstanding for CDS contracts for H2 2012 dropped 6.91% to US$25.069 trillion, from US$26.93 trillion for H1 2012.
This means the cumulative reduction for CDSs’ outstanding notional since June 2011 is US$7 trillion – partly due to contract compression, whereby economically redundant derivatives trades are terminated without changing the net position of each position, the report states.
“Overall notional CDS amounts continued to slip as a result of stricter bank risk limits, rising concerns over the US fiscal cliff and sovereign credit downgrades,” said Zohar Hod, global head of sales at US risk management and market data services firm SuperDerivatives.
“FX derivatives remain in demand as hedging instruments due to the crucial role they play in facilitating cross-border trade and providing stability to businesses,” Hod added.
BIS said the data masked a larger overall decline due to the depreciation of the US dollar against the euro and Swiss franc from June to December last year, which increased the dollar value of contracts denominated in those currencies.
Hod believes the results reflect the participants’ concerns about the future of the OTC derivatives market as new regulation begin to come into force, namely Title VII rules within the US Dodd-Frank Act.
“Uncertainty in the regulatory space remains the real bug bear for both the buy- and sell-side, which have yet to get a clear steer on the costs of using these instruments to manage risk going forwards,” he said. “OTC derivatives remain an essential and integral part of risk management for institutions across the board, but as expected, this uncertainty has had an impact on overall volumes.”
Dodd-Frank rules are coming into force on a rolling basis, which began earlier this year with major swaps participants reporting OTC derivatives trades to trade repositories. From 10 June, most US buy-side firms will have to begin centrally clearing OTC derivatives trades.
In anticipation of the new rules, exchanges have offered futures instruments structured to replicate the function of swaps, but which avoid the more costly intensive regulatory requirements for OTC derivatives. Swap futures have seen significant growth since they emerged in the second half of last year, although a growing number of market participants have claimed the disparity between swaps and futures rules forms an uneven competitive environment.