Growth in the notional amount of outstanding over-the-counter derivatives has been slowing, and the troublesome category of credit default swaps has been shrinking, for about the last three years, according to tracking surveys by the International Swaps and Derivatives Association.
Now from derivatives infrastructure servicer TriOptima come further indications that notional exposures are coming down, reducing the aggregate risks in OTC markets that have been of particular concern to financial regulators around the world.
TriOptima, a unit of London-based interdealer brokerage ICAP serving the major derivative dealers and more than 100 other bank and nonbank clients, said its triReduce compression program, which aggregates trades among multiple participants and enables them to eliminate significant numbers of inefficient bilateral negotiations, reduced interest-rate swap and credit default swap notionals by $45.8 trillion and $8.5 trillion, respectively, in 2010. Those figures were reached in 53 IRS and 95 CDS compression cycles, both record numbers.
The IRS cycles, in 23 currencies, were up from $26.7 trillion in 2009, while CDS has fallen drastically from a peak of $30.2 trillion in 2008 and $14.5 trillion in 2009. The cumulative notional-amount terminations since the introduction of triReduce in 2003 stand at $108 trillion in IRS and $68.2 trillion in CDS.
“We expanded the range of interest rate swap currencies we cover to Israeli shekel and Thai baht,” said TriOptima North America CEO Raf Pritchard, citing factors contributing to what he called “another successful year” for triReduce. “Terminations in currencies like these with higher capital requirements can free up capital for redeployment and reduce counterparty credit risk,” he added. “Furthermore, with strong cycles in Japanese yen and eight other Asian currencies, our activities in Asia continue to gain traction.”
The TriOptima results reinforce the trendlines in the most recent semi-annual data from the Washington-based ISDA, showing IRS and currency swaps at $434.1 trillion notional outstanding, 5 percent higher than a year earlier and 2 percent more than at the end of 2009.
While IRS were still rising, though well below the 30-plus percentage rates of 2006 and 2007, notional totals of credit default swaps were decreasing by 16 percent between the first halves of 2009 and 2010, to $26.3 trillion. CDS, which had peaked above $62 trillion in 2007, had fallen back to early 2006 levels.
Speaking at ISDA’s September 2010 regional conference in New York, association CEO Conrad Voldstad calculated that the risk-reducing measures of central clearing and eliminations or “tear-ups” of redundant trades had together reduced outstanding CDS volumes by nearly 75 percent.
In the interest rate swaps market, $100 trillion of trades had been torn up to date, Voldstad said, and $210 trillion had been centrally cleared as of the end of 2009. Adding ISDA’s estimate that another $200 trillion could be cleared within the next few years, “that would leave less than $80 trillion” in uncleared IRS in a market of $500 trillion, he said.
What’s more, tear-ups of IRS that have already been cleared hold significant promise for further risk reduction. On top of about $30 trillion of cleared swaps transactions that had been torn up in 2010, ISDA said at the time, “it might be possible to tear up another $200 trillion in currently cleared swaps.”
Voldstad said some aspects of the OTC derivatives market structure are easy to overlook in assessing its risk profile. On the IRS side, he said, fewer than 2,000 standardized swaps were executed in an average day; most trade 20 times or fewer in a day. In all, there might be 600 U.S. dollar trades and 400 euro trades a day.
Citing data from Depository Trust and Clearing Corp., which jointly owns the MarkitSERV OTC trade processing platform with Markit Group, for the previous six months, Voldstad said only five CDS names – all sovereign entities – averaged 20 trades per day. Some single reference names have many distinct contracts available for trading, he pointed out.
The figures speak to “a market that has much less volume than one might imagine from the $600 trillion figure we all talk about,” said Voldstad. “They are much more consistent with a market where less than $100 trillion is not cleared.”
Jeffrey Kutler is editor in chief of Risk Professional magazine, published by the Global Association of Risk Professionals.
