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OTC Derivatives: Trading,
Reporting & Regulations
Udaipur
8th Jan 2011
Introduction
The family of OTC derivatives includes is classified by asset class - Interest Rate, FX, Credit, Equity and
Commodity derivatives.
OTC
Derivatives
Interest Rate
Foreign
Currency
Credit
Equity/
Commodity
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Background
•
Includes the gamut of Interest Rate, FX, Credit and Currency Derivatives
•
Primarily plain vanilla products involving currencies or interest rates
•
Interest Rate Derivatives is the largest subset with Swaps predominating
•
A gradual shift from OTC to exchange traded products
−
Fragmented Markets vs Concentrated Markets
•
On line Trade reporting for Rupee IRS since 2007 has massively improved transparency and price
discovery
•
Initiatives underway around trade reporting and central clearing of all OTC products
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Global Context
•
20% CAGR from 1995 in the use of Interest Rate and Currency Derivatives
•
70% growth in the use of Credit Derivatives since inception
•
Current Estimated Outstanding
•
•
−
$400 Tn in Interest Rate and Currency Derivatives
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$ 65 Tn in Credit Derivatives
−
$ 10 Tn in Equity Derivative
Daily Estmated Turnover
−
$1.7 Tn in Interest Rate Derivatives
−
$0.3 Tn in Currency Derivatives
Credit derivatives - heavily in the news due to the sub-prime crisis
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Domestic Context
•
Plain Vanilla IRS introduced in 1999
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Currency Forwards in existence for long, FX Options introduced in 2005
•
Credit Derivatives, currently not allowed but in advanced discussion stage
•
Equity and commodity derivatives due to the nature of their underlying markets have moved to
exchanges
•
Current Outstanding
−
Rs 46 lac crore in Interest Rate Derivatives
−
Rs 36 lac crore in Currency Derivatives
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Products
•
Interest Rate Derivatives include IRS, FRAs
•
The IRS dealt include OIS, INBMK, MIFOR
•
Currency Derivatives include the basic FX forwards, Swaps and Options
•
Credit Derivatives (CDS) currently disallowed but in the process of being introduced with appropriate
safeguards
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Interest Rate Derivatives
•
Introduced in 1999 and has seen immense growth and popularity
•
Gross Outstanding contracts in the region of Rs21 lac cr; however net is much lower
•
Daily volumes in the region of Rs10,000cr
•
In recent times has acted as useful hedge for interest rate risk
•
Key applications include short term asset management and duration management
•
Participation remains essentially foreign bank skewed
•
Local banks can play a key role in balancing the market interest and closing the existing arbitrages
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Interest Rate Derivatives - Benchmarks
OIS
Overnight inter bank call
money rate
Most Liquid - Average Daily
Volume INR 200 bio
MIFOR
INBMK
Implied rupee interest rate
derived from USD vs INR
forward rates.
Benchmark is the 1 year GOI
yield
Hedge for Currency swap
positions with clients
Used primarily for duration
management of bond
portfolios
Liquid Up to 5 years
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Currency Derivatives
•
Gradual evolution from forwards to matched swaps to position taking
•
FX Forwards represent the largest portion of this segment
•
FX Options allowed in 2005 has tremendously benefited corporate wishing to put on shorter term
hedges
•
Underlying exposure continues to be a key requirement to ensure orderly markets
•
Latest guidelines issued Dec 28th
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Key Issues in OTC Derivatives
•
Established Client need - customized solutions, hedge effectiveness
•
OTC markets criticized for being opaque, but are the largest component of world financial markets
−
3 decades history
−
Participants are large, professional institutions mostly banks hence regulated
−
Transparency to regulators versus transparency to all
•
Capital charge on counterparty exposures and for market risk
•
Reporting required for MTM, systemic stability, regulatory information
•
Trade compression, focus on net risk or open interest
•
Price impact of post-trade dissemination
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Transparency
•
•
Pre-trade transparency
1.
Interbank quotes
2.
Single screen offering
3.
Composite levels
Post-trade transparency
1.
Trade repository
2.
Confirmations
3.
Payment advice
4.
Collateral management
5.
Valuation
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Road Ahead for OTC Derivatives
•
Standardized contracts
•
Trade repository
•
Central Clearing
•
Electronic Trading system, anonymous order matching
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Review of Capital charges
•
Post trade services
•
New Products (swaptions, caps/ floors) to be introduced in a phased manner
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