Outstanding OTC Derivatives Volumes

A derivative contract can base it value on different kinds of underlying assets such as a physical commodity, an interest rate, a company’s stock, a stock index, a currency, or virtually any other tradable instrument upon which two parties can agree. An over-the-counter (OTC) derivative is a bilateral, privately negotiated agreement that transfers risk from one party to the other.

Derivatives can either be over-the-counter—meaning a one-off, private, customized contract—or exchange-traded—meaning a standardized contract that is traded through an exchange.

Since 1998 the Bank for International Settlements (BIS) has published semi-annual data on outstanding OTC derivatives contracts for G10 countries and Switzerland, conducting every three years a global survey among 54 central banks and monetary authorities.

According to the BIS, the objective of the semi-annual survey is to obtain comprehensive and internationally consistent information on the size and structure of derivatives markets in the G10 countries and Switzerland. It includes notional amounts outstanding and gross market values, and helps to monitor the evolution of particular OTC derivative market segments.

Following the financial crisis and the recession afterwards, the U.S. introduced new regulation of derivatives as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (generally known as Dodd-Frank). Barack Obama signed the Dodd Frank Act on July 21 2010 as response to the Great Recession including changes to the American financial regulatory environment.

The Title VII of Dodd-Frank addresses former gaps in the U.S. regulation of OTC swaps. It divides regulatory authority over swap agreements between the Commodity and Future Exchange Commission (CFTC) and the Security and Exchange Commission (SEC), while the Federal Reserve Board, also has a role in setting capital and margin for banks. The SEC has regulatory authority over “security-based swaps,” which are defined as swaps based on a single security or loan or a narrow-based group or index of securities (including any interest therein or the value thereof), or events relating to a single issuer or issuers of securities in a narrow-based security index.  The CFTC has regulatory supervision on all the other swaps, such as energy and commodity swap.

There is a big difference between the notional amounts of outstanding OTC derivatives contracts—the face value of the underlying asset—and the gross market value of the outstanding contracts themselves.

The notional amount is the actual value of the asset on which the contract is written, but parties to a derivative contract are seldom required to pay out the full value of the asset, hence the notional amount outstanding is seen as a poor reflection of the actual risk. The gross market value, in contrast, is the total amount paid by companies for outstanding contracts.

In the first half of 2014, OTC derivatives markets contracted. The notional amount of outstanding contracts totaled $691 trillion at end-June 2014, down by 3% from $711 trillion at end-2013 and back to a level similar to that reported at end-June 2013.

The gross market values of outstanding OTC derivatives continued to trend downwards in the first half of 2014. Gross market values was $17 trillion at end-June 2014, down by 7% from $19 trillion at end-2013 and 14% from $20 trillion at end-June 2013. Whereas, in 2013,

the decline had been concentrated in interest rate derivatives, in the first half of 2014 the gross market value of foreign exchange derivatives also fell significantly.