Growth in derivatives trading gains pace, says BIS

Trading on derivatives exchanges has continued to pick up pace, said the latest Bank for International Settlements (BIS) Quarterly Review, released in June. The combined turnover in interest rate, equity and currency derivatives rose by a quarter between January and March to $429 trillion. But the growth of trade in credit default swaps (CDSs) slowed.

Trading in interest rate products grew by 26% in the first quarter, amid expectations of higher interest rates in the US and Japan. Uncertainty over the timing of US interest rate rises caused a 38% increase in the trading of short-term US interest rates. Turnover in futures and options on 30-day federal funds doubled to $36 trillion in the first quarter, while open interest in these contracts rose by 70% to $12 trillion.

Elsewhere, the ending of the Bank of Japan's quantitative easing policy in March and expectations of the first interest rate rise in five years led to a sharp increase in trading activity. Turnover in futures on three-month euro/yen deposits rose by 55% in the first quarter, while trading on options on euro/yen futures grew twelvefold. In contrast, futures and options on three-month Euribor rose by only 4% to $75 trillion.

Stock index derivatives

The BIS also reported an 11% increase in the notional turnover of stock index derivatives to $43 trillion. However, this was entirely down to valuation effects caused by rising stock prices - turnover measured by number of contracts was almost unchanged from the previous quarter.

Energy derivatives turnover surged by nearly 40%, amid concern over Iran's nuclear programme and potential supply problems. Volumes grew by 51% and 44% in North America and Europe, respectively.

However, growth in credit default swaps trading slowed in the second half of 2005. The notional amounts of CDSs increased by a third to $14 trillion, compared to a 60% increase in the first six months of last year. Growth in single-name CDSs outpaced that of multi-name contracts, with growth rates of 40% and 21% respectively.

The results revealed that the CDS market is largely interbank. The report broke down participant exposures to banks and security dealers, as well as insurance companies. At the end of 2005, two-thirds of all outstanding positions were between dealers, with a quarter between dealers and other banks or securities firms.

Just 3% of CDS transactions were with non-financial institutions. Insurance and financial guarantee firms accounted for $180 billion, or about 2%, of the protection bought, and less than 1% or $60 billion of the protection sold. Other institutions, including mutual funds and hedge funds, accounted for 11% of the trades.

- Jayne Jung.