The long period of rapid growth in the global derivatives industry was checked in 2008, with both over-the-counter (OTC) and exchange-traded business slowing in the final months of the year.
The findings are revealed in the new edition of Derivatives, a research report from International Financial Services London(IFSL).
Moves to centralize the clearing of some OTC derivatives contributed to a 13% decline in notional outstanding value of contracts in the second half of 2008, from USD684 trillion in June to USD592 trillion at the year end. This marked the first such fall since the Bank for International Settlements (BIS) started collecting statistics in 1998.
Centralized clearing has now become more common for some classes of OTC derivatives contracts. This includes interest rate swaps, commodities and credit default swaps (CDS). Moves to centralized clearing have been prompted by concerns about systemic risk particularly related to damage caused by collateralized debt obligations.
CDS saw an even larger drop of 28% in the second half of 2008, with voluntary termination of contracts also playing a role. London is the leading global centre for OTC derivatives, with 43% global market share, compared with 24% in the US. London is also central to the development of niche OTC markets in energy, freight and carbon trading.
The global decline in OTC trading volumes comes as regulators consider greater future regulation of OTC derivatives.
Sir Stephen Wright, Chief Executive, International Financial Services London, said: Its vital that Londons leading position is not undermined by any future reform to the conduct of derivatives business in the United States or the European Union. IFSL urges that any changes to the regulatory framework surrounding derivatives ensure that these products remain widely available as a risk management tool.
All four London-based exchanges NYSE Liffe, LME, ICE Futures Europe and EDX London – had a record year in number of contracts traded in 2008, with NYSE Liffe passing 1 billion contracts for the first time. This reflects Londons continuance as a major location for global exchange-traded derivatives trading. 98% of NYSE Liffe turnover by value, for example, takes place on the London exchange, while more than 45% of Eurex trades have originated in the UK since 2003.
However, while some exchanges had a record year, this was based primarily on high turnover in the early months of 2008. The overall aggregate value of global exchange traded turnover slumped by 47% in the year to the first quarter of 2009, although most of this decline was during 2008: the fall had slowed to 3% between the fourth quarter of 2008 and first quarter of 2009.
Duncan McKenzie, Director of Economics at IFSL, said. Year on year the value of exchange turnover could drop by 25% in 2009. While exchange trading could eventually be lifted by proposed reforms, future growth of OTC derivatives will be more dependent on opening up of new markets including those in emerging economies.