understand the OTCD markets and their level of importance to the proper functioning of the global economy and financial system.
|The Global Risk Transfer Market:
Developments in OTC and Exchange-Traded Derivatives
The seemingly complex and rarified world of OTC derivatives (OTCDs) were thrown into the spotlight over the past few years; playing the unwitting, but partially deserved, role of protagonist in one of world history’s greatest financial dramas. In the wake of this catalytic event, the world has clamored to
Despite all the attention, the resulting level of understanding remains unsatisfactory, uninformed, or both. The OTCDs market cannot be simply characterized as a $615 trillion behemoth. Instead, it needs to be viewed as what it really is: a key component of a broader market for risk transfer products designed for financial institutions, corporations and investment managers around the world. Moreover, OTC and exchange-traded derivatives (ETDs) are actually two interdependent, complementary and sometimes competitive siblings within a single, global risk-transfer mechanism where wholesale, retail and customized risk-transfer needs are simultaneously being met. TABB Group estimates that at the end of 2010, the Global Risk Transfer Market (GRTM) will represent $700+ trillion of notional values outstanding with turnover of more than $3.7 quadrillion annually.
One of the many underappreciated aspects of the GRTM today is the fact that total ETD activity consistently represents a majority of annual notional turnover, or over $2 quadrillion for 2010. Furthermore, with open interest of $80 trillion, the ETD market sees a turnover rate of 25 times per year, as compared to turnover rates of 2 to 3 times for the OTCD market. It is the long track record of structural integrity in the ETD market that not only allows for such extreme levels of activity and turnover, but that it also does so with little contribution to financial market disruptions.
The spirit of current regulatory reforms, primarily in the US and the EU, is intended to foster the transition of the OTCD market to an ETD-like operational paradigm, while preserving the utility of these markets for end users as well as minimizing disruptions and excess costs for brokers and service providers. What this means in practice is a major push to centralized clearing, optimal use of collateral, and mechanisms to promote greater pre- and post-trade transparency. Some of this transformation is very much in process already, with market participants devising and implementing solutions in an effort to respond to needs and influence outcomes.
Trading activity, protocols and cost structures will change – mostly for the better. Assimilation of leading economies in APAC, like China and India, will eventually have a monumental effect on aggregate notional values outstanding. Operational and risk advancements will lead to significant increases in OTCD market diversity, liquidity and overall turnover. One of the main challenges of this transformation centers on increased use of collateral and the opportunity costs that it represents.
The impacts and outcomes of the ongoing GRTM transformation is varied since different asset classes embody different attributes and serve different end users. For instance, with each unit of turnover in interest rate swaps representing $300 trillion to $350 trillion of new activity globally it is no wonder that the spotlight remains focused on this important and rapidly changing marketplace.
The TABB Group Study on the Global Risk Transfer Market: Developments in OTC and Exchange-Traded Derivatives
This 78 page report – with 72 exhibits - represents a detailed and unprecedented comparative analysis of OTC and exchange-traded derivative markets with focus on market sizing, trade costs and the anticipated impacts of current regulatory reforms. In particular, the report illustrates how OTC and exchange-traded derivatives are two interdependent, complementary and competitive components of a single, global risk transfer market that serves all players across all needs.