6:31 AM Dec 19, 1995


Geneva 18 Dec (Chakravarthi Raghavan) -- Nearly two trillion dollars of value of derivatives instruments (mostly swap instruments on exchange rate, interest rate, equity and commodity derivatives), are being traded on exchanges and over the counter (OTC), according to a survey published by the Basle-based Bank of International Settlements (BIS).

In comparison to this gigantic daily speculative activities, the WTO's latest statistical publication estimates the total annual value of merchandise exports in 1994 as just above $4 trillion dollars while that of commercial services was put at $1.1 trillion.

The value of OTC traded contracts was put at $839 billion a day, while the daily turnover of exchange-traded interest rates and future contracts amounted to $1.1 trillion according to the BIS.

The BIS estimated the notional amount of outstanding OTC contracts at a $40.7 trillion on 31 March, and gross market value of replacement costs of these contracts at $1.7 trillion or about four percent of notional value.

However, experts in international organizations said that the first would be a misleading indicator of the risks and the second, replacement costs, arising when one of the parties to a contract goes bankrupt and can't fulfil it, is not also a easy indicator of risks.

BIS itself says the gross market value of the OTC outstanding is broadly indicative of gross current claims represented by outstanding OTC contracts. But in practice actual credit exposure would be reduced by use of bilateral netting and collateral arrangements and thus will be smaller than gross market value.

The BIS survey (end of March for over-the-counter, OTC, trading, and average of April for exchange-traded activities) for the BIS was carried out by central banks and monetary authorities in 26 countries -- 21 OECD countries (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Singapore, South Africa, Spain, Sweden, Switzerland, UK and the USA) and developing countries (Bahrain, Hong Kong, Singapore and South Africa).

According to the BIS, derivative contracts involving single-currency interest rates accounted for 65% of the notional amount of outstanding OTC contracts at end-March 1995, while those involving foreign exchange accounted for 32%. Equity and commodity price derivatives accounted for one percent each.

Looking across all market risk categories, BIS survey says, that forward and swap-related transactions, at 83%, represented the great majority of outstanding OTC contracts in terms of notional amounts.

Within foreign exchange derivatives, the US dollar figured on one side of 83% of all outstanding contracts -- with USD/Japanese Yen accounting for 28 of these and the US/Deutsche Mark for 16%. Only five percent of foreign exchange contracts involved none of these three.

Within the category of single-currency interest rate derivatives, contracts on US dollar interest rates accounted for 35% of outstandings, and those on Japanese yen and Deutsche Mark interest rates account respectively for 21% and 13% of the total.

In equities derivatives, contracts involving European stock or stock indices represent 46% of total; and almost half of contracts involving commodities were struck on gold.

Whether or not traded in organized exchanges, derivatives, as Andrew Cornford points out in an article in a forthcoming issue of the UNCTAD Review, are contracts specifying rights and obligations between parties, based upon performance of some underlying instrument - investment, currency, commodity or service, index, right or rate.

Derivatives have a long history as forward contracts for trading in goods on organized markets, with speculation instruments on foreign exchange rates joining these ranks later. They serve as instruments to manage financial risks (of the principals), and gradually have been used by financial intermediaries to lay off their own risks. Exchanges around the world have introduced an expanding range of financial futures and options, spawning an enormous growth of financial derivatives. In OTC trading, the most widely used instruments are currency and interest-rate swaps.

From simple swaps, these instruments have become a combination of generic contracts, according to Cornford -- swaps, options on swaps, option on options. Derivatives have become part and parcel of the management of their assets and liabilities by banks and investors. But hedging and speculation with derivatives, by domestic and external portfolio investors are growing and there are efforts in nascent financial centres of developing countries to establish exchanges intended purely to attract business.

These may lead to markets where speculation predominates (with operators not merely taking advantage of arbitrage points of interest and exchange rates, but also the extent of actual regulation and enforcement by domestic authorities) and are capable of posing threat to the stability of financial system, he warns.

The BIS survey was carried out in spring of 1995 by the authorities of participating countries in their local markets to shed light on size and structure of the global OTC market. This is intended to serve as a basis for further consideration by central banks of an internationally coordinated system for regular collection of statistics on OTC derivatives markets.

Since the collapse in 1971 of the Bretton Woods fixed exchange rate system and its replacement by floating exchange rates, the world stock and exchange markets are like a giant casino -- with the financial and monetary system effectively private. Private operators on the market are constantly trying to show that they can beat the controls by creating new instruments, while the central bankers continue to make suitable noises about their ability still to keep on top and control the non-system - a case perhaps of the speculation devil's existence depending on the market god and vice versa.