- Category: Basel III
- Published: Thursday, 19 December 2013 08:19
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The OTC interest rate derivatives market in 2013
by Jacob Gyntelberg and Christian Upper
This feature analyses the market for OTC interest rate derivatives using data from the Triennial Central Bank Survey. Low and stable interest rates after the financial crisis went hand in hand with low but still positive turnover growth in most currencies. The increase was entirely driven by a larger volume of contracts with financial institutions other than dealers. The share of inter-dealer trades has shrunk to 35%, the lowest since the survey's inception. Despite rapid growth in emerging market currencies, trading remains concentrated in major currencies and financial centres. Changes in regulation have led to more contracts being centrally cleared. 1
After growing rapidly prior to the financial crisis, activity in the market for over-the-counter (OTC) interest rate derivatives, such as swaps and forward rate agreements (FRAs), has since expanded at a more moderate pace. Even so, daily turnover averaged $2.3 trillion in April 2013, 14% higher than three years before (Graph 1, left-hand panel).
Activity in this market remains opaque. Admittedly, transparency has improved from the mid-1990s, when central banks expanded their regular survey of activity in foreign exchange markets to also cover turnover and amounts outstanding in OTC interest rate derivatives. And data warehouses and clearing houses provide some data on the transactions they process. Even so, the Triennial Survey remains to date the most comprehensive source of information.
This special feature uses data from the latest Triennial Survey, covering April 2013, to shed light on the structure of the OTC interest rate derivatives market and to analyse the main drivers for activity. We find that low and stable interest rates after the financial crisis have gone hand in hand with low but still positive turnover growth in most currencies. A larger volume of contracts with financial institutions other than dealers coincided with declining inter-dealer activity, causing the share of inter-dealer trades to shrink to 35%, the lowest since the inception of the Survey. The volume of transactions with non-financial firms also declined. Despite rapid growth in emerging market currency activity, trading remained concentrated in major currencies and financial centres. Changes in regulation have resulted in more contracts being centrally cleared.
The first section briefly reviews the main instruments, currencies, trading locations and players in this market. In the second section, we look at some of the potential reasons for the slowdown in turnover growth. The final section concludes.
The OTC interest rate derivatives market in April 2013
As interest rates deeply influence the performance of both financial and non-financial firms, the enormous size of markets for derivatives that facilitate their hedging and reallocation should come as no surprise. With an average of $7.4 trillion per trading day in April 2013, total turnover in interest rate derivatives, including both exchanges and OTC markets, was well above the $5.5 trillion traded in the FX segment. 2
OTC contracts account for only one third of turnover in the interest rate segment but make up the bulk of the open positions. Notional amounts outstanding of OTC interest rate derivatives stood at $561 trillion in mid-2013, far above the $62 trillion of open interest on the international derivatives exchanges. This discrepancy reflects differences in the structure of the two markets and in the maturity of the contracts. Exchange-traded futures and options tend to have much shorter maturities than OTC derivatives. Shorter maturity increases turnover relative to outstanding amounts. Furthermore, on an exchange, offsetting positions are routinely netted out. In contrast, OTC market contracts tend to "pile up". As a result, OTC market participants end up with a large number of offsetting or partially offsetting contracts, resulting in a high total notional amount relative to both turnover and net exposure. That said, this difference between exchange-traded and OTC markets has diminished as market participants make increased use of multilateral termination services to trim the size of their derivatives book (Ledrut and Upper (2007)).
While turnover in OTC interest rate derivatives expanded rapidly up to 2007, growth slowed noticeably after the financial crisis. The annual compound rate of turnover growth fell from well over 20% between 1995 and 2007 to 6% in the subsequent six years (Graph 1, left-hand panel). Turnover growth has varied across instruments. Turnover growth in FRAs (26%) across all currencies outstripped that in swaps (11%). The trading volumes of options contracted slightly, by 4%.
Interest rate swaps remain the most heavily traded contract in the OTC interest rate segment, followed by forward rate agreements (FRAs) and interest rate options (Graph 1, centre panel). The share of interest rate swaps in total turnover stood at 60% in the 2013 survey. This is well below its share on the eve of the crisis, in 2007 (72%), but is in line with the values recorded in previous surveys. The share of FRAs expanded from 15% in 2007 and 29% in 2010 to 32% in 2013, while that of options and other products fell to 7%.