Derivatives Market Declines for First Time on Record
By Abigail Moses
May 19 (Bloomberg) -- The derivatives market shrank for the first time in the second half of 2008 as the global financial crisis curbed trading, the Bank for International Settlements said in a report.
The amount of outstanding contracts linked to bonds, currencies, commodities, stocks and interest rates fell 13.4 percent to $592 trillion, the Basel, Switzerland-based bank said yesterday. That’s the first decline in 10 years of compiling the data. The amount of credit-default swaps protecting investors against losses on bonds and loans fell 27 percent to cover a notional $41.9 trillion of debt.
Investors shunned derivatives as demand for risky assets withered after Lehman Brothers Holdings Inc.’s failure in September. Trading volume may decline further after more than 2,000 banks, hedge funds and asset mangers that trade credit- default swaps agreed to a “Big Bang Protocol” last month that will make it easier to move the contracts to a clearinghouse and eliminate overlapping trades.
“Severely strained credit markets combined with efforts to improve multilateral netting of offsetting contracts” helped cut notional volumes, BIS analysts Jacob Gyntelberg and Carlos Mallo wrote in the report.
Redundant Contracts
The credit derivatives market contracted as traders have already started canceling redundant default swaps to appease regulators and help reduce day-to-day payments and the potential for error.
“At some point you will reach the point where you have netted all your positions and then there is no possibility to further compress any trades,” said Tim Brunne, a Munich-based strategist at UniCredit SpA. “Then I would expect a small increase due to presumably increasing trading activity.”
The cost of protecting corporate debt against default doubled in the second half of 2008, according to the Markit iTraxx Europe Crossover index of credit-default swaps linked to high-risk, high-yield companies. The increase boosted the amount of money at stake in the contracts to $5.7 trillion from $3.2 trillion in the first half of last year, according to the BIS.
Bank Regulation
The Obama administration announced proposals last week to expand regulation of derivatives, which have been blamed for contributing to the failures of Lehman Brothers and American International Group Inc., leading to the seizure of credit markets and causing more than $1.4 trillion in losses and writedowns by financial companies.
If changes are not made “we will be haunted by our failure for years to come,” Brooksley Born, the former U.S. official who lost the fight to regulate derivatives a decade ago, said yesterday as she accepted a Profiles in Courage award from the John F. Kennedy Library.
The data compiled by the BIS, which was formed in 1930 to monitor financial markets and regulate banks, are based on contracts traded outside of exchanges in the over-the-counter market. Interest-rate derivatives remained the largest part of the market, falling 8.6 percent in the second half of 2008 to $418.7 trillion outstanding, the report said.
Foreign exchange contracts fell by 20 percent to $49.8 trillion. The amount of equity derivatives declined 36 percent to $6.5 trillion and those linked to commodities contracted by 67 percent to $4.4 trillion.
Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in interest rates or the weather. Credit- default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. |
