| Amounts Outstanding of OTC Derivatives in US$Billions | |||||
| Jun-04 | Dec-04 | Jun-05 | Dec-05 | Jun-06 | |
| Interest Rate Contracts | 164,626 | 190,502 | 204,795 | 211,970 | 262,296 |
| Forex Contracts | 26,997 | 29,289 | 31,081 | 31,364 | 38,111 |
| Equity Linked Contracts | 4,521 | 4,385 | 4,551 | 5,793 | 6,783 |
| Commodity Contracts | 1,270 | 1,443 | 2,940 | 5,434 | 6,394 |
| Credit Default Swaps | 0 | 6,396 | 10,211 | 13,908 | 20,352 |
| Unallocated | 22,644 | 25,879 | 27,915 | 29,199 | 35,969 |
I have not really had a chance to dissect the figures yet but the things that really leapt out at me were:
- A huge 24% jump in Interest Rate contracts
- A rise in Equity linked contracts of 17%
- Falling growth in Commodity contracts from 27% to 17%
- Another huge rise in CDS of 43%
From the buy-side's perspective I do not think there is much to shock here. Clearly most of the volumes are still sell-side driven, but growth is starting to come from buy-side initiatives like LDI (and thus the use of both IRS and CDS contracts) as well the increasing fear of Equity volatility that seems to be driving people towards Equity Derivatives. As Anthony Bolton noted lately, equities have been touching record highs on both sides of the Atlantic and investors are looking to lock in these prices by using simple stock/index options or (increasingly) by more exotic items such as variance swaps that are capable of isolating volatility (Buying a variance swap is like being long volatility at a pre-agreed level).
The only concern would therefore be that, although the industry as a whole appears to have sorted the confirmation backlog for CDS by automation, the rest of the asset classes are lagging behind and represent significant systemic risk. I suspect that, as happened in 2005, the Fed and the FSA will soon jump in and start demanding action. For Buy Side firms the volumes traded may not be significant (yet) - however I continue to advise my clients that putting the correct tools in place now (such as DerivServ, Swapswire, BClear etc) will save a great deal of pain in the years to come as OTC derivatives become a hygiene factor rather than an exotic sideshow. DerivServ and Swapswire are already starting to battle it out for hegemony in the equity derivative sphere, and new services such as those provided by Euronext are likely to be joined by others entering the fray. I often am asked to speak at conferences on the topic of post trade servicing of OTC derivatives and am constantly amazed at the lack of knowledge in the investment management world of the issues involved and (more importantly) the automation options open to participants. The sooner we automate these processes the sooner we can get on with the really interest stuff....
