Tuesday, June 5, 2012

Some facts about OTC derivatives

We've had a number of questions regarding a post from this weekend that discusses OTC clearing for CDS. People quote scary numbers such as hundreds of trillions in CDS contracts that will surely bring down the global financial system. Let's try to alleviate some of those fears.

1. CDS is 4% of the total notional. The OTC derivatives markets are dominated by interest rate and FX swaps. And these days swap participants who use these products for trading post initial and variation margin as they would with futures.

2. The notional outstanding represents swap purchases and sales. If you trade rate swaps for example, you may be flat rate risk but have a large gross notional. The net numbers are actually quite small globally.

Source: Barclays Capital

3. One of the reasons behind a clearinghouse is to allow end users to easily net their swap purchases and sales - to bring down their gross and reduce counterparty risk. Unlike the issues with CDS described in an earlier post, rate swap clearing is progressing well (we plan to have a guest post on the topic soon). In fact over half of OTC rate derivatives are already centrally cleared.

Source: Barclays Capital

So yes, $648 trillion is the gross notional of OTC derivatives. But people need to understand what that number means, which products are represented, and the market changes now taking place.

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