- The death of uncleared markets has been widely over-reported.
- We look at Clarus CCPView and recent BIS data to look at the size of uncleared markets.
- Interest Rate derivatives remain the largest, followed by FX. Credit is very small in comparison when measured by notional outstanding.
- We strongly advocate further transparency into the remaining stock of uncleared derivatives. More information on these trades would enable the market to better mitage risks.
CCP12 Incentives for Central Clearing
The CCP12 paper, “Incentives for Central Clearing“, includes an overview of OTC derivative markets. It is well worth a read as it goes into considerably more detail than we can in a blog. Amir gave a synopsis in an earlier blog post here.
The paper covers many of the nuances that may impact the calculation of how much of a particular market is being cleared. This is particularly important when considering Notional Outstanding as a measure. We continue to believe that Turnover offers a much better representation of market activity.
I recommend having a read of the CCP12 paper before having a look at today’s blog.
Transparency is still hard to come by for Uncleared Markets
It is that time of year when the latest BIS semi-annual survey of derivatives is released. ISDA got there first with a short overview , but the BIS commentary tends to be the most interesting part.
Crucially, as I have stated in past blogs, the BIS survey is only important for Uncleared markets. The Clarus data product, CCPView, is superior for cleared markets because it has no double-counting and offers far more granularity in the data. It also includes both Turnover and Notional Outstanding data. Contact us for more information.
The Evolution of Uncleared Markets
Let’s therefore take a look at the most important aspect of the BIS data – what is going on with uncleared volumes of derivatives?
Uncleared Interest Rate Derivatives
The largest part of the market by notional outstanding remains interest rate derivatives. Despite all of the noise surrounding uncleared margin rules, clearing mandates and the impending cessation of Libor, the death of uncleared markets has been very much over-reported. They remain alive and well!
- The chart is created using a combination of BIS data and CCPView data. I throw away all BIS data that is marked versus “Central Counterparties”.
- The chart shows that the notional outstanding of uncleared Interest Rate Derivatives stood at $105 Trillion as at the end of 2018.
- This has been remarkably stable since 2016, in a range of $98 – 114 trillion.
Some readers may be thinking how is this possible? If we have clearing mandates across the major jurisdictions, who is still trading uncleared derivatives? Are these just old trades that refuse to mature? The answers can be summarised as:
- Much of this notional outstanding reflects new activity in the major uncleared markets – most notably Swaptions. Swaptions trade over $1trn every single month in US markets alone, none of which is cleared.
- Some of this new activity will be offset by maturing trades where the hedges are now being done in cleared markets due to liquidity or due to mandates.
- There remain significant market participants who are exempt from clearing mandates.
The net balance is to see a relatively stable stock of uncleared IRDs. Compression is not as effective in uncleared space due to CSA-specificity, and with the nature of participants more likely to be directional, it looks like this stock of trades is there to stay.
As the CCP12 paper concluded, it would be a fascinating study to learn more about these open positions and why they are not moving to clearing.
Onto the FX portion of the survey, which includes FX swaps/forwards, Options and Cross Currency Swaps. I was surprised to see that uncleared FX Derivatives are not quite as large as uncleared Interest Rate Derivatives:
- A total uncleared notional outstanding of $88trn as of December 2018.
- Again, this has been remarkably stable since 2016, in a range of $77 – $93bn.
- It is disappointing that the volumes from BIS do not include a split for NDFs. To examine the real portion of the NDF market being cleared, we have to resort to a myriad of data sources.
Without any clearing mandates in FX, and NDFs only a small portion of the overall FX market, most of the open interest in FX markets is uncleared.
On which note, it is worth having a read of Jon Skinner’s recent posts to get a feeling for where FX markets are and how Clearing might fit into the picture – potentially as a post-trade credit exposure mitigation technique (much as it was originally designed to be in Rates markets).
And now for Credit. This really is a different story:
- A sustained reduction in Notional Outstanding of uncleared credit derivatives.
- It has reduced from $7.9 trillion to $3.9 trillion in just three years, a handy 50% reduction.
What is so different in Credit compared to Rates and FX? Off the top of my head:
- Trading is strongly concentrated in Index products, of which 99%+ in US markets is cleared.
- There are Clearing Mandates in place for these products.
- The products wisely adopted market-wide standards that make them highly efficient in a cleared environment.
- CCPs keep on launching new products to clear?
Now we get down to the main motivation of writing the blog. Is the uptake of Clearing increasing in each of the asset classes? Reading the BIS commentary suggests that it has somewhat stagnated – but as the CCP12 paper highlights, this is probably due to highly efficient compression in clearing distorting the measurements when made by Notional Outstanding.
Nonetheless, let’s run the numbers across the asset classes. We use Clarus CCPView data for a single-counted view of Cleared markets versus the BIS data for Uncleared markets:
- By Notional Outstanding, 65% of all Interest Rate Derivatives were cleared.
- 1.1% of FX Derivatives were cleared. For NDFs alone we know this figure is much higher – 16% as at October 2017, highlighting that I need to update that analysis!
- 32% of Credit Derivatives were cleared.
- 50% of all Derivatives were cleared.
We strongly agree with the CCP12 paper that measuring clearing rates in this way is a misguided measure of the success of clearing.
Clearing Rates should be measured using turnover statistics.
Unfortunately, we have to wait for the next BIS Triennial Survey to update those figures, and weekly blog deadlines do not give me that luxury!
Therefore, I will leave the final comment to the BIS itself, who brings together a few of our blog topics very nicely (links changed from the originals to our Clarus blogs!):
The rise of central clearing has been an important structural change in OTC derivatives markets over the past decade. This change has gone hand in hand with an increase in trade compression – the elimination of economically redundant derivatives positions – both of which primarily affected interest rate contracts, driving down their market values. New practices such as settle-to-market – where banks, instead of posting collateral against the change in market value (ie variation margin), make outright payments to restore the market value to zero – have additionally contributed to the observed decline in their market values. Market values for foreign exchange contracts have been less affected by these developments, as only the non-deliverable forwards segment is cleared.BIS: OTC derivatives statistics at end-December 2018
- 50% of OTC notional outstanding was cleared as at end 2018.
- This significantly understates the portion of current trading activity that is cleared.
- More transparency into the 50% of the market that remains uncleared would be very welcome.
- With more transparency into these uncleared markets, solutions to mitigate risks can be proposed for these important markets.