Capital Markets

Report: OTC Derivatives Up 40 Percent in 2006

By far the fastest-growing component last year was credit-default swaps.
Stephen Taub and Dave CookMay 21, 2007

The over-the-counter derivatives market grew last year from $298 trillion to a notional outstanding value totaling $415 trillion worldwide as of December 2006, according to a report by the Bank for International Settlements.

That 12-month surge — nearly 40 percent — was the largest since the bank began issuing its twice-yearly report in 1998, according to Bloomberg. The BIS pointed out, though, that after a 24 percent jump in the first half of the year, total over-the-counter growth held to 12 percent in the second six months, “in line with the long-term average rate of increase in the market.”

By far the fastest-growing component last year was credit-default swaps. Their value more than doubled, to nearly $29 trillion, from about $14 trillion at the end of 2005.

Bloomberg observed that last week, Federal Reserve Board chairman Ben Bernanke said that credit derivatives “increased the resilience” of financial markets but warned that they may be exploited by investors who profit from insider trading.

In a separate story last week, Bloomberg noted that European Central Bank president Jean-Claude Trichet warned that credit derivatives may create risks to the financial markets if events prompt investors to bail out at the same time. Investors “may react in a way that can suddenly lead to dangerous herding behavior,” he reportedly said at the annual meeting of the International Swaps and Derivatives Association. “Such situations are also a matter of concern from a systemic liquidity viewpoint.”

Though it grew somewhat less quickly, the largest component of the derivatives market continues to be interest-rate contracts. Last year their value climbed more than 40 percent, to about $292 trillion, accounting for roughly 70 percent of the total derivatives market.

The BIS also reported that gross market values held steady at about $10 trillion as of the end of last year. Since they “measure the cost of replacing all existing contracts,” they also “represent a better measure of risk at a given point in time than notional amounts,”
according to the bank. After allowing for netting agreements, gross credit exposures stemming from over-the-counter derivatives also remained stable, at $2 trillion, the BIS reported.