The global OTC derivatives market at end-June 1999

The BIS is releasing today its semiannual statistics on positions in the global over-the-counter (OTC) derivatives market for end-June 1999. These statistics constitute the third 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(1) They cover the four main categories of market risk: foreign exchange, interest rate, equity and commodity.

After adjustment for double-counting resulting from positions between reporting institutions, the total estimated notional amount of outstanding OTC contracts stood at $81.5 trillion at end-June 1999, a 1% increase over the $80 trillion reported for end-December 1998.

The most striking development was a sharp reduction in foreign exchange contracts, a segment that had already begun to decline in the second half of 1998. At the same time, interest rate contracts continued to grow, albeit at a slower pace. Equity-linked contracts expanded modestly, while commodity contracts returned to growth following a contraction in the second half of last year. Interest rate instruments remain by far the largest component of the OTC market (66%), followed by foreign exchange products (18%) and those based on equities and commodities (with 2% and 0.5% respectively).

The slowdown in interest rate contracts (with growth of 8% compared with 18% in the previous period) was accounted for largely by swaps. In contrast, activity in FRAs and interest rate options accelerated. The expansion in business in the second half of 1998 appears to have been related to the unwinding of leveraged positions through offsetting contracts after the financial turbulence associated with the Russian debt moratorium(2) 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 pronounced contraction of activity in currency instruments (with the stock of open positions dropping by 17%) was accounted for by outright forwards and forex swaps (-21%) and options (-19%). Again, the introduction of the euro was a determining factor. The stock of contracts involving euro area currencies declined by 35% in the first half of 1999. The reduction in historical and implied volatility in the dollar/yen currency pair, which had experienced unprecedented swings in the second half of 1998, was associated with a decline in contracts involving these two currencies. The main exception to this pattern of decline occurred in the area of cross-currency swaps, which increased modestly. This contrasting development may have been related to strong primary market activity in global securities markets.

Calmer market conditions were reflected in a 19% drop in estimated gross market values in the first half of 1999, to $2.6 trillion. Taking into consideration the increase in the overall stock of transactions, market values dropped from 4% to 3% of reported notional amounts. 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 at $1.1 trillion.

1The 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 30 June 1999.
2In the OTC market, while positions may be unwound by assignment or termination of the original contract, it is more common for this to be done through new contracts with the opposite positions.