The Bank for International Settlements reported that OTC derivative volumes increased to a record $708 trillion, up 18% for the first half of 2011. I have some theories on why:
- Increased volatility in FX and commodities, and the concerns around hedging credit risk with Credit Default Swaps (CDS) drove up volumes.
- Interbank interest rate swap trading activity increased as trading opportunities presented themselves in various basis and yield curve spreads.
- Swap dealers have started to better centralize their swap data across products and desks in preparation for reporting to the Swap Data Repositories (SDRs) under the upcoming Dodd-Frank regulation.
I suspect the last bullet may be the most relevant and that perhaps the prior year’s data were not as accurate as they should have been. Until all Swaps are physically reported to SDRs under Dodd-Frank, it will be hard to believe any number that is reported. And frankly, the gross notional volume report is relatively meaningless unless compared to notional exposure that is being hedged or with the net notional amount. Better yet, some risk number starting with current mark-to-market value would have more meaning. For example, $2.9 trillion notional of CDS on sovereign debt could have a net mark-to-market value of $100 billion or $100 million.
The monumental task of setting up and regulating SDRs to capture this all important Swap data is still in its early stages with many of the related definitional rules still pending. US regulators will have to wait until the G20 also completes its rule writing, and then finally they would have to consolidate reporting from dozens of SDRs around the world in order to get the true number. It may be a few years away, and at that point we can be sure that the number reported will be very different.