According to the International Swaps and Derivatives Association (ISDA), a derivative is a risk transfer agreement, the value of which is derived from the value of an underlying asset. More simply, a derivative is a contract between two parties where one party agrees to take on the risk of losses associated with a particular asset—such as a physical commodity or an agreed amount of currency.

Author: Tiziana Barghini

A derivative contract can base it value on different kinds of underlying assets such as a physical commodity, an interest rate, a company’s stock, a stock index, a currency, or virtually any other tradable instrument upon which two parties can agree. An over-the-counter (OTC) derivative is a bilateral, privately negotiated agreement that transfers risk from one party to the other.

Derivatives can either be over-the-counter—meaning a one-off, private, customized contract—or exchange-traded—meaning a standardized contract that is traded through an exchange.

Since 1998 the Bank for International Settlements (BIS) has published semi-annual data on outstanding OTC derivatives contracts for G10 countries and Switzerland, conducting every three years a global survey among 54 central banks and monetary authorities.

According to the BIS, the objective of the semi-annual survey is to obtain comprehensive and internationally consistent information on the size and structure of derivatives markets in the G10 countries and Switzerland. It includes notional amounts outstanding and gross market values, and helps to monitor the evolution of particular OTC derivative market segments.

The Push For Transparency

Following the financial crisis and the recession afterwards, the U.S. introduced new regulation of derivatives as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (generally known as Dodd-Frank). Barack Obama signed the Dodd Frank Act on July 21 2010 as response to the Great Recession including changes to the American financial regulatory environment.

The Title VII of Dodd-Frank addresses former gaps in the U.S. regulation of OTC swaps. It divides regulatory authority over swap agreements between the Commodity and Future Exchange Commission (CFTC) and the Security and Exchange Commission (SEC), while the Federal Reserve Board, also has a role in setting capital and margin for banks. The SEC has regulatory authority over “security-based swaps,” which are defined as swaps based on a single security or loan or a narrow-based group or index of securities (including any interest therein or the value thereof), or events relating to a single issuer or issuers of securities in a narrow-based security index.  The CFTC has regulatory supervision on all the other swaps, such as energy and commodity swap.

Market Developments

There is a big difference between the notional amounts of outstanding OTC derivatives contracts—the face value of the underlying asset—and the gross market value of the outstanding contracts themselves.

The notional amount is the actual value of the asset on which the contract is written, but parties to a derivative contract are seldom required to pay out the full value of the asset, hence the notional amount outstanding is seen as a poor reflection of the actual risk. The gross market value, in contrast, is the total amount paid by companies for outstanding contracts.

In the first half of 2014, OTC derivatives markets contracted. The notional amount of outstanding contracts totaled $691 trillion at end-June 2014, down by 3% from $711 trillion at end-2013 and back to a level similar to that reported at end-June 2013.

The gross market values of outstanding OTC derivatives continued to trend downwards in the first half of 2014. Gross market values was $17 trillion at end-June 2014, down by 7% from $19 trillion at end-2013 and 14% from $20 trillion at end-June 2013. Whereas, in 2013,

the decline had been concentrated in interest rate derivatives, in the first half of 2014 the gross market value of foreign exchange derivatives also fell significantly.

Outstanding OTC Derivatives Volumes,

Gross market values
Gross market values
Risk Category / Instrument
Total contracts 641,309 696,408 691,492 25,519 20,245 17,423
Foreign exchange contracts 66,672 73121 74,782 2,249 2,427 1,722
Forwards and forex swaps 31,395 34,421 35,190 773 957 571
Currency swaps 24,156 24,654 26,141 1,190 1,131 939
Options 11,122 14,046 13,451 286 339 213
Interest rate contracts 496,215 564,673 563,290 19,216 15,238 13,461
Forward rate agreements 65,181 86,892 92,575 52 168 126
Interest rate swaps 380,720 428,385 421,273 17,317 13,745 12,042
Options 50,314 49,396 49,442 1,848 1,325 1,292
Equity-linked contracts 6,313 6,821 6,941 639 692 666
Forwards and swaps 1,880 2,321 2,433 147 206 191
Options 4,434 4,501 4,508 492 486 475
Commodity contracts 2,993 2,458 2,206 379 384 269
Gold 523 461 319 51 80 32
Other commodities 2,471 1,997 1,887 328 304 237
Forwards and swaps 1,659 1,327 1,283      
Options 812 670 604      
Credit default swaps 26,930 24,349 19,462 1,187 725 635
Single-name instruments 15,566 13,135 10,845 715 430 368
Multi-name instruments 11,364 11,214 8,617 472 295 266
of which index products 9723 10,163 7,939      
Unallocated 42,185 24,986 24,810 1,849 779 670
Memorandum Item:
Gross Credit Exposure
      3,692 3,784 2,842