Derivatives Stage A Comeback
Neville, Laurence, Global Finance
Market participants are rediscovering the appeal of derivatives, and the providers that stayed the course during the recent meltdown are reaping the benefits.
World's Best Derivatives Providers
In the year covered by Global Financed sixth awards for the World's Best Derivatives Providers, the world of finance changed beyond recognition, and the derivatives markets have been no exception. While the receivers of Lehman Brothers and AIG are still unraveling the complex trades that brought the two firms down, the wider market is digesting the implications of the financial crisis in terms, of regulation, trading practices and the number of market participants.
In the immediate aftermath of the crisis, many derivatives markets fell sharply, with the credit derivatives market - which was the heart of many of the world's banks' problems - worst affected. Tentative growth has since returned - with the exception of the credit derivatives market, which continues to shrink - as stability has begun to. return to the financial system.
Market participants have rediscovered the benefits of derivatives for customized risk management solutions to help navigate the more uncertain economic landscape, according to Eraj Shirvani, chairman of the International Swaps and Derivatives Association (ISDA) and head of fixed income for EMEA at Credit Suisse. "This continued growth is a testament to both the utility of derivative instruments and to the industry's ongoing efforts to reduce risk and enhance operational efficiency," he says.
According to ISDA s most recent survey of over-the-counter (OTC) derivatives trading, which covered the first half of 2009, the notional amount outstanding of credit derivatives - credit default swaps referencing single names, indexes, baskets, securitized obligations and portfolios - decreased by 19% in the first six months of the year to $31.2 trillion from $38.6 trillion. Over the preceding 12 months, credit derivative notional amounts decreased by 43% from $54.6 trillion at mid-year 2008.
In contrast, notional amount outstanding of interest rate derivatives, which include interest rate swaps and options and cross-currency swaps, grew by 3% to $414.1 trillion from $403.1 trillion. This compares with a 13% decrease from $464.7 trillion during the second half of 2008. Over the preceding 12 months, interest rate derivatives decreased by 11% from $464.7 trillion in mid-2008.
Despite the strong run in many global stock markets from March onward, notional amount outstanding of equity derivatives, which consist of equity swaps, options and forwards, remained relatively flat at $8.8 trillion for the first half of the year. This compares with a 27% decrease from $11.8 trillion during the second half of 2008.
Figures from the Bank for International Settlements, which measures activity on derivatives exchanges, show similar trends. During the second quarter of 2009, total turnover based on notional amounts increased to $426 trillion from $366 trillion in the previous quarter, consistent with a return of risk appetite. The increase was mostly accounted for by derivatives on shortterm interest rates, where turnover rose to $344 trillion compared to $294 trillion in the previous quarter.
Turnover in equity index derivatives also increased in the second quarter, from $37 trillion to $43 trillion, chiefly as a result of rising equity valuations. Global turnover measured in the number of contracts traded rose by less than 300 billion. Activity in foreign exchange derivatives began to recover as well, with turnover increasing to $5.9 trillion from $4.8 trillion in the preceding quarter.
Trading in commodity futures and options increased slightly in the second quarter. Global turnover in commodity derivatives measured in numbers of contracts (notional amounts are not available) stood at 446 million, compared to 423 million in the previous quarter. Major contributors were contracts on agricultural products and non-precious metals, while trading in energy derivatives fell. …