Derivatives market

The derivatives markets are the financial markets for derivatives. The market can be divided into two, that for exchange traded derivatives and that for over-the-counter derivatives। The legal nature of these products is very different as well as the way they are traded, though many market participants are active in both.

Futures markets

Main article: Futures exchange

Futures exchanges, such as Euronext.liffe and the Chicago Mercantile Exchange, trade in standardized derivative contracts. These are options contracts and futures contracts on a whole range of underlying products. The members of the exchange hold positions in these contracts with the exchange, who acts as central counterparty. When one party goes long (buys) a futures contract, another goes short (sells). When a new contract is introduced, the total position in the contract is zero. Therefore, the sum of all the long positions must be equal to the sum of all the short positions. In other words, risk is transferred from one party to another. The total notional amount of all the outstanding positions at the end of June 2004 stood at $53 trillion. (source: Bank for International Settlements (BIS): [1]). That figure grew to $81 trillion by the end of March 2008 (source: BIS [2])

Over-the-counter markets

Tailor-made derivatives traded on a futures exchange, are traded on over-the-counter markets, also known as the OTC market. These consist of investment banks who have traders who make markets in these derivatives, and clients such as hedge funds, commercial banks, government sponsored enterprises, etc. Products that are always traded over-the-counter are swaps, forward rate agreements, forward contracts, credit derivatives, etc. The total notional amount of all the outstanding positions at the end of June 2004 stood at $220 trillion. (source: BIS: [3]). By the end of 2007 this figure had risen to $596 trillion (source: BIS: [4])

Netting

Global: The notional outstanding value of OTC derivatives contracts rose by 36% from $197 trillion at end-2003 to $270 trillion in June 2005. Since end-2000, notional value has increased nearly threefold. Average daily global turnover rose from $764bn to $1508bn between April 2001 and April 2004. The UK reinforced its position as the leading derivatives center with its share of turnover rising from 36% to 43% during this period.

Interest rate instruments remain the key driver of global trading, accounting for 76% of notional value. Derivatives based on foreign exchange contracts also form an important sphere of activity as do equity-linked and commodity contracts. Credit, energy, metal and freight derivatives have grown rapidly in recent years. The euro and the US dollar dominate interest rate derivatives worldwide with 37% and 35% shares respectively based on notional value in June 2005. Turnover data for April 2004 indicated a rather higher share for euro-based derivatives trading. Financial institutions such as hedge funds, mutual funds, insurance companies and smaller banks have become much bigger users of derivatives. [5]

US: Figures below are from September, 2005 [6]

• Total derivatives (notional amount): $96.2 trillion (September, 2005)
  • Interest rate contracts: $82.0 trillion
  • Foreign exchange contracts: $8.6 trillion
• Total number of commercial banks holding derivatives: 769