News | Derivatives
OTC risk is on downward slope says ISDA
Risk is on a downward slope in over-the-counter (OTC) derivatives market as traders embrace a range of practices that have significantly reduced the notional amount outstanding on OTC contracts. In its year-end analysis of
OTC trades executed in 2012, the International Swap and Derivatives Association (ISDA), records a 3.3% drop in the notional amount outstanding on OTC trades over the year, excluding FX transactions. However, when the double- counting of cleared transactions is eliminated, the magnitude of the decline is much steeper: 10.9% over 2012 and 17.5% over the last five years. Portfolio compression,
the practice of eliminating duplicate or matched trades from dealers’ portfolios, has had the biggest impact on risk reduction, reducing notional amounts outstanding by 25%. In 2012, $48.7 trillion worth of OTC derivatives, including $44.6 trillion of interest rate derivatives, were eliminated by matched trades while the figure for the last five years tops $214 trillion. But while portfolio
compression reduces the size of the OTC market, the central clearing of OTCs has the opposite but artificial effect of increasing notional outstanding.
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during the second half of 2012 while gross credit exposure, a measure that shows the impact of netting, declined from $3.7 trillion to $3.6 trillion and was 14.6% of gross market value. Collateralisation further reduces credit exposure and, together, netting and collateral cut gross market value to 0.2% of notional amounts outstanding. “The industry has made
Robert Pickel, CEO, ISDA
This is because, in a cleared transaction, a bilateral trade between two parties is counted by clearers as two separate trades, with the result that the notional amount outstanding in the market doubles in size. At the end 2012, some $173.2 trillion of OTC trades, including 53.5% of all interest rate derivatives, were centrally cleared. In addition to portfolio
compression and clearing, the practices of netting and collateralisation have also mitigated risk in the OTC market, says ISDA. Gross market value, the market value of all outstanding contracts before netting and a good measure of credit exposure, declined from $25.4 trillion to $24.7 trillion
strides to reduce counterparty credit risk and help make the derivatives markets safe and efficient through netting, collateralisation, portfolio compression and central clearing,” says Robert Pickel, chief executive officer of ISDA. “While the increase in compression continue to impact adjusted OTC derivatives volumes, underlying market activity remains robust.” Meanwhile ISDA’s 2013
Margin Survey of 78 firms, indicates that there is now some $3.7 trillion worth of collateral in circulation. Although the figure has remained fairly static over the year, the fact more business is being cleared suggests a continued underlying growth in the collateralisation of bilateral OTC derivatives, says ISDA. Nearly 70% of all non-cleared trades are subject to collateral agreements with the figure rising to over 75% for larger firms. n
Best Execution | Summer 2013
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