Credit derivatives to hit $33 trillion by 2008, says BBA

The global market for credit derivatives is expected to reach $33 trillion by the end of 2008, according to a British Bankers’ Association (BBA) report released at its credit derivatives conference last week.

The BBA predicted the market will rise to $20 trillion by the end of this year, well outperforming the $8.2 trillion estimated for 2006 in the BBA’s 2004 survey. The figures fall short of the International Swaps and Derivatives Association’s $26 trillion already reached for the first half of 2006. This discrepancy is due to definitional differences over which contracts are included, and also reflects the difficulty of measuring over-the-counter derivatives.

The main players in the credit derivatives market remain hedge funds and banks. Hedge funds have doubled their share of the market in selling credit protection, from 15% in 2004 to 32% in 2006, reflecting their stature as a growing force in the market. They have similarly expanded their share as buyers of credit protection, from 16% in 2004 to 28% in 2006. This growth has eclipsed that of the banks, but a stabilisation is expected over the next two years, with hedge funds predicted to account for 30% of both sides of the market by 2008.

Banks still hold the greater part of the market participation in buying and selling credit protection, but their market share has dropped from 67% of buying in 2004 to 59% in 2006, and 54% of selling in 2004 to 44% in 2006, showing a slower growth rate than the hedge funds. Hedge funds have supplanted insurance companies as the second largest sellers of credit protection. Insurance companies as a whole represent 17% of sellers in 2006, down from 20% in 2004 and 33% in 2002.

The growth in market size has been matched by an expanding variety of products on offer and shifts in product use. Innovations in full index trades have proved popular, growing from 9% of the market share in 2004 to the second most used in 2006, with 30% of the market share, overtaking synthetic CDOs, which represent 16%. Single-name credit default swaps have lost market share for the first time, down to 33% in 2006 from a high of 51% in 2004.

Ross Barrett, wholesale director of the BBA, said index trades have expanded so rapidly “because they offer more flexibility in tailoring them to what clients want, such as in terms of the performance of an index or equity, whereas single-named CDSs are more vanilla now.” Barrett said alternative products, such as recovery swaps, could gain ground over the next two years.

London remains one of the world’s dominant centres for trading credit derivatives, holding just under 40% of global market share, and is estimated to trade over $7 trillion by the end of 2006 and over $10 trillion by the end of 2008.

The BBA’s bi-annual survey is based on the responses of market leaders in credit derivatives.