The over-the-counter (OTC) derivatives market is experiencing substantial growth, with interest rates on the rise, according to the latest report from the Bank for International Settlements (BIS). This surge results from market fluctuations and the significant impact of the phasing out of London interbank offered rate (LIBOR) rates.

BIS' report for mid-2023 highlights a surge in interest rate derivatives (IRDs) and FX derivatives. IRDs had increased 17% as at the end of June due to multiple factors, including the impact of rising dollar and euro interest rates. Additionally, the changes in the benchmark LIBOR rates impacted the product mix in IRDs.

Shifting OTC Derivatives Markets

Notably, the decline in forward rate agreements (FRAs) denominated in key currencies marked a substantial change. Currencies like GBP, JPY, and CHF witnessed a decline in FRAs. The dollar-denominated FRAs reached $14 billion during the transition from the LIBOR rates.

Additionally, the BIS report highlighted the increasing rate of central clearing , particularly in credit default swaps, which reached a record high of 70%. Despite this, the clearing rate for credit default swaps remained below that for the IRDs. The data also indicated a continuous rise in central clearing for FX derivatives, albeit much slower, remaining below 5%.

The report indicates a remarkable surge in the gross market value of OTC derivatives, which reached $20.7 trillion by the end of 2022. The hike in inflation and policy rate increases globally contributed to this surge, particularly in interest rate derivatives.

Changes in market rates, surpassing the rates prevailing at the initiation of IRD contracts, significantly boosted their gross market value. Euro and US dollar-denominated IRDs substantially increased as the market adapted to the evolving economic conditions.

OTC Derivatives Landscape Stabilizes

Interestingly, while gross market values soared, the notional value of outstanding derivatives remained relatively stable. The reform in benchmark Libor rates significantly impacted the instruments used, notably affecting FRAs denominated in key currencies.

Conversely, commodity derivatives, especially in energy and food, experienced a decline in gross market values and notional values. This significant drop aligned with the fall in commodity prices observed in 2022, indicating a direct correlation between market fluctuations and derivatives' values.

Meanwhile, the regulation of OTC derivatives is evolving globally. Recently, Canadian securities regulators introduced rules to govern OTC derivatives for dealers and advisers. Aligned with international standards, these regulations aim to foster transparency, ethical practices, and accountability in Canada's OTC derivatives market.

The newly adopted rules impose significant responsibilities on OTC derivatives dealers and advisers. These mandates include fair dealing, conflict of interest management, reporting non-compliance, and proper recordkeeping.