Uncontrolled Growth

Although slightly dated in light of the various developments that have taken place during the past six months, the latest Bank for International Settlements report on the global derivatives market makes for interesting reading.

Not only did total outstanding positions at the end of December hit a new record, so did the pace of year-on-year increases. As I've noted before, the heady -- some would say uncontrolled -- growth rate of recent years will prove to be very troubling for the financial system and the economy in the period ahead.

In "Derivatives Markets Grow 15 pct in 2H 2007 -BIS," Reuters details some key points from the BIS report.

The over-the-counter derivatives market grew 15 percent in the second half of 2007 to $596 trillion, slowing from a 24 percent increase in the first half as the credit crisis took hold, the Bank for International Settlements said.

Growth was strongest in credit default swaps, foreign-exchange derivatives and commodity derivatives, the Swiss-based BIS said in a report released on Thursday.

Credit default swap volumes rose 36 percent to $58 trillion, it said, with growth led by contracts on multiple names -- such as the credit indexes.

Market participants used indexes such as the iTraxx indexes heavily in the second half of the year both to hedge exposures to illiquid instruments such as leveraged loans that were falling in value as well as to take a view on the development of the credit crisis.

Among single-name instruments, growth was led by contracts on companies rated below investment grade or without ratings -- those viewed as riskier than investment grade.

Foreign exchange derivatives grew 16 percent in the second half of 2007 to $56 trillion, although growth in contracts involving British pounds slowed to 3 percent. Interest rate derivatives grew 13 percent to $393 trillion, the BIS said.

Equity derivatives volumes shrank 1 percent, the first time this has happened since the second half of 2004, to $8.5 trillion.

However, there was robust growth in commodity derivatives, up 19 percent in the second half to $9 trillion, the BIS said. Gold showed a high growth rate of 40 percent, versus a fall of 33 percent in the first half.

Spot gold prices rose some 27 percent in the second half of 2007 as investors sought safe havens from the credit storm, and started 2008 at a 28-year high.

In addition, here is a chart I put together (using BIS data) that shows the trend over the past few years.