The exchange-traded derivatives market has been one of the few highlights of the post-financial crisis period, driven by innovative products such as exchange-traded fund options and volatility index derivatives in the developed markets of the US and Europe, along with the boom in equity, currency, and commodity derivatives in the emerging markets such as Brazil, India, and China, according to a new report from Celent.
Global Exchange-Traded Derivatives: A Silver-Lining Amid Dark Clouds?, reveals that exchange-traded derivatives have seen healthy growth rates over the last few years. In terms of notional amount outstanding, futures grew by 14.95% between 2005 and 2010, with options growing by 14.67% over the same period. Overall, the market has been able to cope with the effect of the global financial crisis well.
The clear lead that the developed markets, especially the US, have in terms of innovation, with exchanges such as the CME Group, Eurex, NYSE Euronext, Nasdaq OMX, and CBOE Group being among the top ones. The introduction and success of products such as exchange-traded fund options and volatility index derivatives are a testament to this. These exchanges have benefited from high profitability and are now exploring the opportunities available in the emerging market as well. The partnership between the CME Group and BM&FBovespa, as well as the cross-listing of index futures between a number of exchanges, are signs of this development. Celent expects this trend to become stronger in the future.
The sharp growth in volumes of established products such as stock index derivatives, currency derivatives, and commodity derivatives once these are introduced in the emerging markets. In the next few years, the growth in the exchange-traded derivatives segment is expected to come from the emerging markets such as Korea, China, Brazil, and India. Five of the leading derivatives exchanges are from these countries already and it is expected that the continued economic growth is to lead to higher volumes in the future as well. However, it would be useful to mention the difficulty that the Asian exchanges have had in terms of introduction of interest rate derivatives. The illiquid nature of the underlying bond market has meant that these derivatives have not been successful outside Japan and Australia.
The OTC derivatives market dwarfs its exchange-traded counterpart. In 2010, the exchange-traded market was a little more than 8% of the OTC market in terms of notional outstanding. This puts into perspective the monumental task regulators and market participants have in terms of the introduction of central clearing for OTC derivatives. Clearing has been successful in the exchange-based environment, but the volumes are more than tenfold in the OTC market, and the effort required to make the OTC market safer is unprecedented. Comparing exchange-based derivatives with the cash equity market, we can see that the performance of the two differed widely in 2009 and 2010. The cash equity market has seen falling volumes and turnover, with few of the leading global exchanges experiencing growth. By stark contrast, the leading derivatives exchanges all experienced growth in 2010. The volatile conditions were part of the reason that liquidity moved into derivatives.
An important recent development for the exchange-traded market is the introduction of legislation that is going to make central clearing compulsory in markets such as the US and Europe. This is going to increase the complexity of trading such products and will drive some volumes towards exchanges, where the complexity and cost of trading standardised derivatives is expected to be lower.
According to Celent’s analysis, the derivative segments that will benefit most from these regulatory changes include commodity and currency derivatives, followed by long-term interest rate options and single stock derivatives. It is important to note that it would be the leading exchanges in the US and Europe that would see the benefit of this migration of OTC derivatives, because most of the OTC trading occurs in these markets.
