sponsored by:

financial markets series

DERIVATIVES
novemBer 2012

nYse euronext (nYX) is a leading global operator of nancial markets and provider of innovative trading technologies. the companys exchanges in europe and the United states trade equities, futures, options, xed-income and exchange-traded products. With approximately 8,000 listed issues (excluding european structured Products), the company's equities markets the new York stock exchange, nYse euronext, nYse mkt, nYse alternext and nYse arca - represent one-third of the worlds equities trading, the most liquidity of any global exchange group. the company offers comprehensive commercial technology, connectivity and market data products and services through nYse technologies. nYse euronext is in the s&P 500 index. nYse euronexts international derivatives business, nYse liffe, is europes largest exchange by value of business traded, and the second largest globally. it brings together the ve european derivatives markets of amsterdam, Brussels, lisbon, london and Paris, supported in london by our european central counterparty, nYse clearing. nYse liffes customers include banks, pension and hedge funds, algorithmic and proprietary traders, as well as institutional and individual investors, whose trades are executed via our state-of-the-art electronic trading platform. Business worth 1480 billion 20 million a second is traded through nYse liffe every day and we are a driving force in the global derivatives markets. nYse liffe offers its customers a variety of derivatives products including interest rates, bonds, equities, indices and commodities. in addition to complement our central order book services we offer customers a choice of wholesale services including Bclear, a service for those who want to conduct business away from the central order Book but who still want the benets of central clearing and processing.

thecityUk champions the international competitiveness of the nancial and professional services industry. created in 2010, we support the whole of the sector, promoting Uk nancial and professional services at home and overseas and playing an active role in the regulatory and trade policy debate. thecityUk has a global export focus with a commitment to help Uk based rms grow their business in other parts of the world. in 2010, the nancial services industry accounted for 9% of Uk GDP and 11% of Uk tax receipts. the sector currently employs over one million people, more than 66% of whom work outside london, and underpins the businesses that drive jobs and growth. added together with nearly one million employed in professional services, it is easy to see the importance of a sector that employs 7% of the working population. thecityUk provides constructive advice and is the practitioner voice on trade policy and all aspects of taxation, regulation, and other legislative matters that affect the competitiveness of the sector. We conduct extensive research and run a national and international events programme to inform the debate. our senior team regularly engages with regulators and policymakers at home and overseas, ensuring the sectors views are represented at the highest levels. We are tasked with creating a new vision for the nancial services sector. We are focused on supporting policymakers and business to deliver the new policy ideas which will help deliver growth.

sponsored by:

DERIVATIVES
NOVEMBER 2012
Chart 1

This report reviews developments in the derivatives markets globally. The industry has undergone reform in recent years but, with a major agenda of post-crisis regulation yet to be implemented, there are concerns about achieving a balance between regulation that delivers safe markets and the costs of participation in those markets. Such a balance would ensure that markets continue to function on a basis that is economically viable, particularly in relation to the management of business risks. Trends in derivatives markets worldwide have been uneven since 2008: exchange trading recovered in 2010 and 2011 but is likely to be down in 2012. UK banks net spread earnings from derivatives make a large contribution to the UK financial services trade surplus.

International derivatives market

$ trillion, notional amounts outstanding, June & December 700 600 Over-the-counter 500 400 300 200 100 0 1998 2000 2002 2004 2006 Exchange-traded

2008

2010 2012*

*March 2012 Source: Bank for International Settlements

OVERVIEW OF TRADING
Global market Derivatives provide users of both financial and nonfinancial services with mechanisms to manage a broad spectrum of business risks. In common with other parts of the financial services the derivatives industry has undergone reform following the financial crisis of 2008. A continuing concern of providers and users of derivatives since 2008 has been that with a major post-crisis agenda of regulatory change yet to be implemented,a balance is achieved as outlined in the introduction above. A focus on global regulatory reform features on page 3.

Chart 2
Location of interest rate OTC derivatives
Average daily turnover in April, % share 45 40 35 30 25 20 15 10 5 2001 2004 2007 2010

OTC derivatives markets The notional outstanding value of OTC

derivatives contracts fell by 8% to $648 trillion in the six months to end0 December 2010. Notional value remains at broadly the same level as the UK France Switzerland US Japan Singapore $673 trillion high before the financial crisis in June 2008 (Chart 1, Table Source: Bank for International Settlements (next survey April 2013) 1). Relative stability in notional value since end-2008 contrasts with the sustained growth that had characterised OTC derivatives market Table 1 Measures of activity in international derivatives markets over the previous 15 years. Recent trends are linked with the moves to netting and central counterparty clearing of some contracts, $ trillion, end-period* particularly CDS, that followed concerns about systemic risks posed OTC market 2006 2007 2008 2009 2010 2011 Notional value 418 508 673 595 601 648 by some OTC derivatives. Gross market value, which peaked at Gross market value 10 16 35 22 21 27 $35.3 trillion at end-2008, fell to $19.5 trillion in June 2011 before Gross credit exposure 2.0 3.3 5.0 3.5 3.5 3.9 picking up to $27.3 trillion in December 2011. The UK has a dominant position as the global centre for OTC derivatives trading, with a 46% share of OTC interest rate derivatives in April 2010 (Chart 2): the next triennial survey being scheduled for
Exchange-traded derivatives Notional value 69 Turnover (period) 1.8 Number of contracts traded 12.0 (bn, period) 79 2.3 15.5 58 2.2 17.7 73 1.7 17.7 68 2.0 22.4 57 2.2 25.0

*Except where stated Source: Bank for International Settlements, Futures Industry Association

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

April 2013. The US accounts for a further 24% of turnover with the next largest locations being France and Japan. Turnover has become increasingly concentrated as market share of the 10 largest firms in the UK increased from 71% in 2001 to 92% in 2010. Interest rate instruments remain the mainstay of OTC derivatives, accounting for 78% of global notional value. The share of derivatives based on foreign exchange contracts makes up a further 10% and credit default swaps 4.4%, with the latter having fallen from 7.0 % in 2008. In terms of notional value the euro is the largest currency with 36.6% of trading of single currency interest rate derivatives at end-2011; closely followed by the US dollar with 32.1%. The other major currencies traded are the Japanese yen 13.3% and the pound sterling 8.6%. Freight derivatives have become firmly established over the past decade: trading by the larger UK-based shipbroking houses totalled 1.3m lots in 2010 with a drop to 1.2m in 2011. There are a range of participants in energy derivatives with strong growth in the value of trading in energy OTC derivatives, up by 56% to $921bn in the year to June 2011.

Chart 3
International exchange traded turnover by value
$ trillion, quarterly value of turnover 700 600 500 400 300 200 100 0 2000 2002 2004 2006 2008 2010 2012

Source: Bank for International Settlements

Exchange-traded derivatives Value of turnover increased by 20%

in 2010 and by 9% in 2011 to reach $2,160 trillion, recovering from a low point of $1,662 trillion in 2009. A drop in quarterly turnover to around $425 trillion in the three quarters between Q4 2011 and Q2 2012 would, if sustained, result in a 20% drop in exchange-traded turnover during 2012 (Chart 3). Based on notional value of trading, the biggest exchange groups worldwide are CME Group, NYSE Liffe and Eurex. London has a prominent role in global exchange-traded derivatives. The 1,603 million contracts traded on UK-based derivatives exchanges in 2011 was virtually the same as the 1,604m in 2010. Trading on UK exchanges is down to 749m in the first half of 2012. While trading at NYSE Liffe is likely to be down over the year, both ICE Futures Europe and the London Metal Exchange could see a new high in the number of contracts traded in 2012 if trading in the first nine months of the year is sustained during the final quarter. NYSE Liffe is the leading exchange in the trading of short-term euro interest rate contracts (STIRs), which account for 97% of NYSE Liffe turnover by value. More than 90% of international business in nonferrous metal futures is transacted at the London Metals Exchange. ICE Futures Europe is the leading electronic global exchange for energy products. European Climate Exchange, part of ICE Futures Europe, is the leading carbon markets exchange in Europe for futures and options trading. Turquoise enables trading in Russian, Norwegian and UK equity derivatives. CME Group, which has operated in London for more than 30 years, is seeking to strengthen its position following its application to the FSA to establish a London-based derivatives exchange. UK banks net spread earnings from derivatives transactions with overseas clients totalled 10bn in 2011, over a fifth of UK financial services trade surplus of 46.7bn in that year.

Measures of derivatives used in BIS survey

Nominal or notional amounts outstanding provide a measure of market size, and can also provide a rough proxy for the potential transfer of price risk in derivatives markets. They are also comparable to measures of market size in related underlying cash markets. Gross market value supplies information about the scale of gross transfer of price risks in the derivatives markets. Essentially it represents of the cost of replacing all existing contracts. It provides a measure of market size and economic significance that is readily comparable across derivatives markets and products. Gross credit exposure represents the current value of contracts that have a positive market value after taking account of legally enforceable bilateral netting agreements, i.e. it measures netted credit exposures between counterparties. Turnover data collected in the triennial survey provide a measure of market activity, and can also provide a rough proxy for market liquidity. Turnover is defined as the absolute gross value of all new deals entered into during the month of the surveys, and is measured in terms of nominal or notional amount of the contracts.

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

GLOBAL REFORM OF DERIVATIVES REGULATION

The financial crisis has generated a shift towards a more intensive set of regulatory and prudential standards that are intended to reduce the potential for failure of firms, to raise capital requirements, to enhance governance, and to make the market place more resistant to shocks. The derivatives industry has recognised the requirement for such global standards in regulation and therefore supports reforms that ensure market stability and reduce systemic risk. However, the industry has echoed concerns of the de Larosire Group that a drive towards too much regulation slows down financial innovation and therefore undermines economic growth in the wider economy. In this context, the industry is concerned that the implementation of various EU regulatory initiatives represents an agenda for providers and users of derivatives that will be complex ,costly and burdensome and will impact on market liquidity, functionality and choice. Global firms will also have to factor in the reach and impact of the US Dodd-Frank Act to activities outside the US and, potentially, the legislative reach of any other jurisdiction in which they are carrying on business.
Chart 4

The priority for providers and users of derivatives is whether or not the new regulatory structures will achieve an authentic balance between on the one hand, regulatory solutions that deliver safe and sound markets and, on the other, the ability of users to ensure there is sufficient diversity and choice in the provision of products and services to manage their risks collectively and at a fair cost: the latter is key to encouraging economic growth and commercial recovery. The authorities are looking to replicate the strengths of listed derivatives markets in OTC derivatives markets. Such strengths include price transparency, multilateral execution, and central counter party clearing. However, it is important that reforms do not impinge on the crucial role of OTC markets in helping firms to manage complex underlying risks and facilitating the development of new contracts and markets; in providing an environment in which smaller and more specialist markets, unsuited to multilateral execution, can survive and grow; and in delivering customised risk-management solutions for specific risks on a cost-efficient and well regulated basis.

OTC derivatives markets

$ trillion, June & December Gross market value 35 30 4 25 20 15 10 5 0 0 Gross credit exposure Gross market value 3 Gross credit exposure 5

1999 2001 2003 2005 2007 Source: Bank for International Settlements

2009

2011

Table 2
Risk instruments in global OTC derivatives markets
Notional amounts outstanding, end-year $ trillion 2005 2008 Interest rates 212 433 Foreign exchange 31 50 Credit default swaps 14 42 Equity-linked 6 6 Commodity 5 4 Unallocated 31 63 Total contracts 299 598 % share Interest rates Foreign exchange Credit default swaps Equity-linked Commodity Unallocated Total contracts 2009 450 49 33 6 3 63 604 2010 465 58 30 6 3 40 601 2011 504 63 29 6 3 43 648

OVER THE COUNTER DERIVATIVES MARKETS

Data on global OTC derivatives markets is generated mainly from statistics compiled by the Bank for International Settlements (BIS) through the six-monthly survey of major market participants and the triennial central bank surveys.

I. Six monthly BIS survey of major market participants

Size Indicators of activity in OTC markets have shown varying trends in
recent years: Notional value As indicated in the overview, the notional outstanding value of OTC derivatives contracts fell 8% to $648 trillion in December 2011 from $707 trillion in June 2011, having previously jumped in the first half of the year from $601 trillion in December 2010 (Chart 1). At its end-2011 position, notional value remains close to the $672 trillion

70.8 10.5 4.6 1.9 1.8 10.3 100.0

72.3 8.4 7.0 1.1 0.7 10.5 100.0

74.5 8.1 5.4 1.0 0.5 10.5 100.0

77.4 9.6 5.0 0.9 0.5 6.6 100.0

77.8 9.8 4.4 0.9 0.5 6.6 100.0

Source: Bank for International Settlements

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

in 2008. Notional value of exchange-traded derivatives at $57 trillion, is less than one tenth of OTC derivatives.

Table 4
Location of interest rate OTC derivatives turnover
Average daily turnover in April -----------------$bn----------------UK US France Japan Switzerland Singapore Netherlands Germany Canada Australia Spain Italy Hong Kong Others Total 2001 238 116 65 16 10 3 24 94 10 10 21 24 3 44 676 2004 563 317 151 31 12 9 19 43 12 13 12 38 11 100 1331 2007 957 525 176 76 61 57 27 90 21 23 17 30 17 96 2173 2010 1235 642 193 90 79 78 61 49 42 41 31 27 19 112 2698 ----------------% shar e-------------2007 2010 2001 2004 42.3 44.0 45.8 35.2 23.8 24.2 23.8 17.1 11.4 8.1 7.2 9.6 2.3 3.5 3.3 2.3 0.9 2.8 2.9 1.4 0.6 2.6 2.9 0.5 1.4 1.2 2.3 3.6 3.2 4.2 1.8 13.9 0.9 0.9 1.5 1.5 1.0 1.0 1.5 1.4 0.9 0.8 1.1 3.0 2.8 1.4 1.0 3.5 0.8 0.8 0.7 0.4 7.5 4.4 4.2 6.5 100.0 100.0 100.0 100.0

Gross market value Gross market value of OTC derivatives had fallen back by 45% to $19.5 trillion in mid-2011 from the end-2008 peak of $35 trillion , before increasing by 40% during the second half to $27.3 trillion at end-2011 (Chart 4). Gross credit exposure Trends in gross credit exposure have closely tracked those of gross market value. Credit exposure fell 41% from the peak of $5.0 trillion at end-2008 to $3.0 trillion in June 2011 before rising 31% to $3.9 trillion at end-2011 (Chart 4).

Risk instruments Interest rates account for the majority of activity in the OTC derivatives market based on notional value. Source: Bank for International Settlements Interest rates share of notional value has risen from 72% at Table 3 end-2008 to 78% at end-2011 (Table 2). The share of derivatives based Single currency interest rate derivatives on foreign exchange contracts has edged up from around 8% to 10% Notional amounts outstanding over the same period. The share of credit default swaps (CDS) has $ trillion, by currency, December 2005 2008 2010 2009 dropped by over a third from 7.0% to 4.4% between 2008 and 2011 81 161 Euro 178 176 (see paragraph on CDS on page 5). The share of equity-linked derivatives 74 149 US dollar 152 153 26 62 Japanese yen 60 54 has been relatively stable at around 1% in recent years, while 15 29 Pound sterling 38 34 commodities share has edged down to 0.5%. 2 3 Canadian dollar 4 3 Currency composition The euro and the US dollar are the most
widely traded currencies in single currency interest rate derivatives, with 36.6% and 32.1% shares respectively in December 2011 (Table 3). Share of both currencies has fallen slightly in recent years, with pound sterling the main beneficiary up from 6.8% to 8.6% in three years to December 2011. The other main currency is the Japanese yen with 13.3%: Swedish krona and Swiss franc each made up just over 1% and other currencies a combined 5.9%, up from 4.4% three years earlier.
Swedish krona Swiss franc Other All currencies % share Euro US dollar Japanese yen Pound sterling Canadian dollar Swedish krona Swiss franc Other All currencies 3 3 8 212 5 5 19 433 5 5 20 450 5 5 24 465

2011 185 162 67 43 6 6 5 30 504

II. BIS coordinated triennial central bank survey (April 2010, next survey April 2013)
Six worldwide triennial surveys have been undertaken since 2005, the most recent in April 2010, with the next survey scheduled for April 2013. Average daily global turnover of interest rate OTC derivatives increased by 24% between April 2007 and April 2010, with much of this growth likely to have occurred in the first half of this period, as notional value indicates that activity reached a peak in the second half of 2008. Coverage of the triennial survey in April 2010 was narrowed to interest rate OTC derivatives alone, but as these account for over three quarters of all OTC derivatives based on notional value they provide a good overall indicator of the trends in total OTC derivatives turnover.

38.4 35.1 12.1 7.1 0.8 1.2 1.5 3.7 100.0

37.3 34.4 14.2 6.8 0.6 1.2 1.2 4.4 100.0

39.1 34.1 12.0 7.6 0.8 1.0 1.1 4.4 100.0

38.2 32.6 12.8 8.1 0.9 1.1 1.1 5.2 100.0

36.6 32.1 13.3 8.6 1.3 1.2 1.1 5.9 100.0

Source: Bank for International Settlements

Chart 5
Counterparties in interest rate OTC derivatives markets
% share of average daily turnover in April Reporting dealers 100 90 80 70 60 50
81% 29% 44% 44% 45% 5%

Other n. instns
2%

Non-n. customers
4%

-------------------World--------------8% 9% 11%

-----------------UK----------------6% 10% 17% 37% 44% 36%

Location International trading in interest rate OTC derivatives is heavily

concentrated in the UK and US, according to the BIS coordinated survey (Table 4). The share of global turnover based in the UK increased further to 45.8% in April 2010 from 44.0% in 2007. The UKs share was more than 10% higher than the 35.2% in 2001. The US share has been relative static at around 24% in the three surveys since 2004 although higher than 17% in 2001. Other main centres in 2010 were France 7%, and

40 30 20 10 0

66% 48% 47% 44%

59% 50%

54%

2001

2004

2007

2010

2001

2004

2007

2010

Source: Bank for International Settlements, Bank of England

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

Japan, Switzerland and Singapore each around 3%. Germanys share more than halved from 4.2% to 1.8%.

Chart 6
Concentration of interest rate OTC derivatives in UK
% share of average daily turnover in April Largest 10 rms 100
18% 30%

Counterparties The major feature of the global counterparty

breakdown was a further rise in the share of non-financial institutions to 11% in 2010 up from 9% in 2007 and 5% in 2001 (Chart 5). Reporting dealers globally saw a drop in share from 47% to 44% between 2007 and 2010, while other financial institutions were more stable at around 45%. While the increasing prominence of non-financial institutions has also been evident in the UK, the growth in reporting dealers share of UK activity from 50% to 54% of UK notional value was in the opposite direction to the global market. Given that the UK accounts for such a large share of turnover, this indicates that the UK probably accounts for over half of global trading between reporting dealers, reflecting the global nature of wholesale financial markets in London.

Next largest 10 rms

11% 15% 15% 6% 15% 5% 14%

Other rms

1%

7%

80

60

18% 92% 79% 81%

40
52%

74% 67%

20

Concentration The OTC interest rate derivatives market in the UK has

become steadily more concentrated amongst the largest firms over the past 15 years. Out of a total of 42 firms in the UK survey, the share of the largest 10 jumped to 92% in the April 2010 survey from 81% in April 2007. Prior to that it had grown from 52% since the first survey in 1995 (Chart 6). The largest 20 institutions in the UK survey accounted for 99% of turnover in the most recent survey. In the US, the other major location, the largest 10 institutions accounted for 95% of turnover in April 2010. The total number of US participating institutions fell to 19 in 2010 from 28 in 2007 as a result of consolidation and exit of some dealers from the market.

1995

1998

2001

2004

2007

2010

Source: Bank of England

Chart 7
Credit default swaps
$ trillion, mid-year & end-year notional amounts outstanding 60 $ trillion, mid-year & end-year market value 6

50

40

4 Notional value

III. Other developments in OTC derivatives markets

Credit default swaps (CDS) In CDS one party promises to pay
another party a fixed fee in exchange for a guarantee that if a bond defaults it will be redeemed. A combination of netting, centralised clearing and reduced spreads contributed to a 48% fall in notional amounts outstanding of CDS worldwide from $58 trillion at end-2007 to $30.3 trillion at end-June 2010. The downward trend in CDS notional value has since tapered, easing to $28.6 trillion in the 18 months to end 2011 (Chart 7). The decline in global market value of CDS has been even steeper, down nearly three quarters from $5.12 trillion at end-2008 to $1.34 trillion in mid-2011, although the second half saw a pick up to $1.59 trillion in December.

30

20 Market value

10

2005

2006

2007

2008

2009

2010

2011

Source: Bank for International Settlements (BIS)

Chart 8
Freight derivatives traded
Forward Freight Agreements (FFAs), millions of lots 2.1 Tanker Dry

Freight derivatives A number of the large UK-based shipbroking

houses have been using freight derivatives to hedge or take a position on the future movement of freight rates. According to Baltic Exchange estimates, the number of lots traded as Forward Freight Agreements (FFAs) in the OTC derivatives market fell from the peak of 2.1 million lots in 2008 to around 1.4m in 2009 and 2010 and to 1.3m lots in 2011 (Chart 8). In 2012 trading was 0.75m lots in the eight months to August, so is likely to ease to 1.2m lots for the full year. The dry bulk market, such as grain and coal, has accounted for just over three quarters of contracts traded since 2009, with tanker trades,mainly oil, making up the remainder. The predominance of dry bulk in trading is

1.8 1.5 1.2 0.9 0.6 0.3 0.0

2006 2007 2008 2009 2010 2011 2012*

*Year to August Source: Baltic Exchange

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

due to the much higher share of freight costs in the dry market.

Table 5
Energy derivatives
Contracts transacted by energy market brokers in the UK, Twelve months ending July Size of market, TWH* UK power UK gas Euro power Euro gas Coal (m tonnes) Emissions (m tonnes) 2005 688 5089 2525 689 415 121 2008 1104 9919 3758 1509 1595 1956 2009 1130 9644 4090 3243 1944 2963 2010 1290 12841 4885 4924 2171 2940 2011 919 16499 6200 6260 2210 2554 % change 2011 -29 28 27 27 2 -13

Energy derivatives There are a range of participants

actively trading energy-related financial instruments including oil and gas producers, utilities, refiners and other industrial consumers, investment banks and hedge funds. The FSAs annual survey of energy market brokers in the year to end-July 2011 showed that, with the exception of emissions trading and volume of UK power, both the volume and value of trading increased in the six asset classes surveyed (Table 5).

The volume of Euro power and gas and UK gas all increased by just over a quarter in the latest survey year while coal volumes were up by 2%, emissions were down 13% and UK power down 29%. An across the board surge in prices, ranging from around 15% for Euro gas and emissions to 60% for UK power, contributed to the value of the energy derivatives market growing by 56% to $921bn in 2011, up from $592bn in 2010.

Notional value of market, $bn 25 UK power 63 54 UK gas 176 77 Euro power 178 7 Euro gas 27 45 Coal 111 2 Emissions 36 178 Total 590 *TWH: terawatt hours Source: FSA survey of energy derivatives markets

65 157 211 56 129 39 657

48 146 188 57 127 25 592

49 299 276 105 168 24 921

2 105 47 83 32 -4 56

Chart 9
Exchange-traded derivatives turnover by region
$ trillion, annual value of turnover 2400 Other regions Europe North America 1600

EXCHANGE-TRADED DERIVATIVES
International exchange trading
Comparisons based on the nominal value of turnover provide the most accurate indicator of the relative size of exchanges, although international trading is more easily compared on the basis of the number of contracts traded. However, comparisons based on numbers of contracts can be heavily influenced by contract sizes selected by each exchange. Small contract sizes raise the number of contracts traded, a particular feature of the Korean, Indian, Mexican and Brazilian exchanges, where individuals account for a larger share of trading.

2000

1200

800

400

Value of turnover Value of turnover increased by 20% in 2010 and

by 9% in 2011 to reach $2,160 trillion, up from a low point of $1,662 trillion in 2009. Recovery in turnover has therefore taken it closer to the earlier high point of $2,287 trillion in 2007 (Chart 9). Quarterly turnover has dropped from around $580 trillion in each of the first three quarters of 2011 to between $418 trillion and $428 trillion in the three quarters between Q4 2011 and Q2 2012 (Chart 3). If trading is sustained at this level, annual exchange traded turnover could be 20% lower in 2012. Turnover of exchange-traded derivatives is heavily concentrated on the exchanges of North America and Europe, which have accounted for around 90% of trading by value in recent years. According to BIS data, 50% of turnover by value in 2011 was based in the North American exchanges, 38% in Europe, 10% in Asia/Pacific and 2% in other regions of the world (Chart 9). The largest exchange is CME Group, which includes the Chicago Mercantile Exchange, the Chicago Board of Trade and New York Mercantile Exchange. NYSE Liffe is the second largest on value of trading, and is followed by Eurex (Chart 10).

2001 2003 2005 2007 2009 2011 2000 2002 2004 2006 2008 2010

Source: Bank for International Settlements

Chart 10
Largest derivatives exchanges
Value of derivatives turnover, $ trillion

1200 1000 800 600 400 200

Eurex

CME Group

NYSE Liffe

2000 2002 2004 2006 2008 2010 2001 2003 2005 2007 2009 2011 Source: CME Group, NYSE Liffe & Eurex

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

Number of contracts traded The number of contracts transacted

through derivatives exchanges worldwide increased by 11% to a record 25.0bn contracts in 2011 from 22.4bn in 2010 (Table 6) . The first half of 2012 has seen a drop in trading to 11.0bn contracts, so the volume of contracts traded could decline by more than 10% over the full year compared with 2011. Based on location of exchanges the US accounted for 33% of contracts traded in 2011, followed by South Korea 16%, India 15% and Germany 8%. Exchanges in the UK made up 6% (Table 6). Trading has grown rapidly in emerging markets, with the share of global contracts traded in exchanges in the BRIC economies rising from 10% in 2005 to 30% in 2011. Korea Futures Exchange, with 3.9bn contracts was the largest exchange based on the number of contracts (Table 7). It is followed by CME Group 2.8bn, National Exchange of India 2.2bn, and Eurex 2.0bn. Regarding UK-based exchanges NYSE Liffe is sixth largest on number of contracts while ICE Futures Europe is 21st and London Metal Exchange 27th.

Table 6
Exchange-traded derivatives turnover by country
Annual number of contracts traded, millions 2005 3525 US 2593 Korea 204 India 1249 Germany 537 UK 466 Brazil 61 Russia 261 China 203 Japan 88 Australia 93 Taiwan 51 South Africa 26 Hong Kong 104 Sweden Other countries 346 9804 Total
1First

-------% share-------2005 2011 20121 36.0 32.5 33.7 26.4 15.7 12.6 2.1 15.2 13.5 12.7 8.4 8.2 5.5 6.8 6.4 4.8 7.8 6.0 0.6 4.6 4.4 2.7 4.5 4.2 2.1 1.5 1.6 0.9 1.2 0.9 0.9 0.7 0.7 0.5 0.8 0.7 0.3 0.6 0.6 1.1 0.5 0.5 3.5 2.7 2.4 100.0 100.0 100.0

2010 2011 20121 7121 8119 3722 3749 3928 1394 2863 3791 1488 1897 2043 931 1604 1603 749 1414 1500 866 656 1099 506 1567 1054 494 376 398 170 106 225 129 140 183 78 170 166 86 116 140 62 109 117 57 537 605 300 22425 24972 11031

six months of 2012 Source: Futures Industry Association

Exchange traded derivatives in the UK

There are four derivatives exchanges based in the UK: NYSE Liffe, London Metal Exchange, ICE Futures Europe and Turquoise.

NYSE Liffe Turnover at NYSE Liffe exchanges in Europe has exceeded

one billion contracts annually since 2008 (Table 8). In 2011 trading fell by 6% to 1,148m from 1,223m in 2010. In the first nine months of 2012 trading totalled 730m contracts, pointing to a drop of around 15% for the full year (Table 8). Trading in short term euro interest rate contracts (STIRs), for which NYSE Liffe is the leading exchange, has accounted for around 97% of the exchanges annual turnover by value in recent years. Based on volume, STIRs account for 47% of contracts and other interest rates 3%; individual equities contribute 35% of trading, Table 7 equity index options 13% and commodities the remaining Largest derivatives exchanges 2% (Chart 14 on page 11).
Annual number of contracts traded, millions

London Metal Exchange Annual turnover of LME

contracts rose to 147m in 2011 from 120m in 2010 and 112m in 2009. Aside from a small drop in 2009, the number of contracts traded has been rising steadily for much of the past decade. Some 119m contracts were traded in the first nine months of 2012: if sustained at this level in the fourth quarter trading at LME would reach a new high for the year of over 158m contracts, up some 8% on 2011. Primary aluminium is the most widely traded metal typically between 42% and 47% in recent years. Copper consistently accounts for about a quarter of trading and zinc around 15%. Lead and nickel accounted for 8% and 6% of trading in 2011. Their share has edged up in recent years. (Breakdown of 2011 volumes in Chart 15 on page 11)
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 27

Exchange

2005 Korea Futures Exchange 2593 CME Group 1765 National Stock Exchange of India Ltd 132 Eurex 1249 Chicago Board Options Exchange 468 NYSE.Liffe 416 Russian Trading Systems Stock Exch. 53 Nasdaq OMX PHLX 163 MCX-SX -BOVESPA 269 International Securities Exchange 449 Bolsa de Mercadorias & Futuros 198 NYSE AMEX Options 202 New York Mercantile Exchange 175 NYSE Arca Options 145 Zhengzhou Commodity Exchange 28 United Stock Exchange of India -Multi Commodity Exchange of India 20 Shanghai Futures Exchange 34 Dalian Commodity Exchange 198 ICE Futures Europe 42 London Metal Exchange 79

2008 2865 2854 590 2165 1193 1050 238 547 -350 1008 392 207 423 417 223 -94 140 313 153 113

2009 3103 2157 919 1687 1135 1056 474 606 224 547 960 373 248 433 421 227 -161 435 417 166 112

2010 3749 2580 1616 1897 1115 1223 624 847 885 803 745 610 440 500 488 496 125 197 622 403 217 120

2011 3928 2842 2200 2043 1152 1148 1083 983 850 841 778 659 619 545 495 406 352 346 308 289 269 147

20121 1394 1275 972 931 568 510 506 407 290 495 332 371 294 280 211 125 4 199 132 196 140 80

1First

6 months of 2012 Source: Futures Industry Association

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

ICE Futures Europe Turnover at ICE Futures Europe has also continued on its rising trend, up by 24% in 2011 to 269m contracts, following a 31% increase in the previous year. With 213m contracts traded in the first three quarters of 2012, a further rise of around 5% to over 280m contracts is projected for 2012 if trading is sustained at this level in the final three months of the year..
Brent Crude futures remains the biggest contract with 50% of turnover in 2011 and 56% in the first half of 2012. The share of West Texas Intermediate, launched in 2006, has declined from a high of 37% of trading in 2007 to 19% in 2011 and 13% in the first half of 2012. Gas oil made up a quarter of trades in 2011. Emissions trading on European Climate Exchange (ECX), which is part of ICE Futures Europe, accounts for 3% of exchange turnover, but ECX is the dominant exchange for futures and options trading in the EU Emissions Trading Scheme, accounting for 98% of turnover in 2011 (Chart 11). Breakdown of contracts traded on ICE Futures Europe is in Chart 16 on page 11.

Table 8
Turnover of derivatives exchanges in London
Millions of contracts traded each year NYSE ICE Futures Liffe LME Turquoise Europe 759.3 78.6 --42.1 2005 730.3 86.9 --92.9 2006 949.0 92.1 --138.5 2007 1049.7 113.2 --153.0 2008 1056.0 111.9 34.9 165.7 2009 1222.6 120.3 44.2 217.1 2010 1148.5 146.6 38.5 269.0 2011 729.6 119.1 25.3 212.6 20121
1First nine months of 2012 Source: Exchanges

Total 880.0 910.2 1179.6 1315.9 1333.6 1604.1 1602.6 749.0

Chart 11
EU ETS futures and options exchange trading
Volume of emissions transacted through futures & options, billion tonnes CO2 7 6 5 4 3 2 1 Other exchanges

Turquoise, established in 2008 and majority owned by the London

Stock Exchange, enables trading in Russian, Norwegian and UK derivatives markets. Trading totalled 25.3m contracts in the first nine months of 2012, so trading for the year is likely to fall short of the 38.5m contracts traded during 2011.

European Climate Exchange (ECX)

Other trading in the UK The UK is an important source of remote

trading for the increasing volume of derivatives business globally that is transacted electronically. A geographic breakdown for the origination of Eurex derivatives contracts data, available until 2009, showed that the share of Eurex contracts sourced from the UK was at least 45% each year from 2003. NYSE Liffe estimates that 60% of its business originates in London. CME Group, which has been operating in London for over 30 years, is seeking to strengthen its presence following its application to establish a London-based derivatives exchange.

2006

2007

2008

2009

2010

2011

Source: Futures Industry Association

CONTRIBUTION OF DERIVATIVES TO UK ECONOMY

Derivatives provide a set of risk management tools for a wide range of organisations, so the wider economic contribution of derivatives is seen in the benefits they bring to individuals and businesses - access to finance at lower costs and controlling foreign exchange risk for importers and exporters. The estimation of derivatives' contribution to the economy in terms of share of GDP, employment and overseas earnings is not straightforward. In other financial markets the value of activity is related to revenue and profits of the firms involved. With derivatives the measures of market activity cannot be so easily ascertained, partly because the value of a derivative is related to the shifting value of the underlying asset. Available data for the UK is set out below.

Employment related to the derivatives markets is widely spread across

trading floors in investment banks, derivatives exchanges, other dealers of futures, options and commodities, and various support and back office

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

functions. It is estimated that there are about 10,000 people employed in derivatives in central London.

Chart 12
UK banks net exports from spread earnings
bn, spread earnings on derivatives transactions

Overseas export earnings include banks spread earnings and net

fee income on derivatives contracts; fee income of futures and options dealers; and fees and commissions on exchange contracts of UK-based derivatives exchanges. Banks spread earnings and fee income Banks generate substantial exports from spread earnings on derivatives, foreign exchange trading and other securities transactions. Net spread earnings on derivatives totalled 10.0bn in 2011, recovering from 7.6bn in 2010. Previously, net spread earnings had grown rapidly from 4.1bn in 2004 to 13.1bn in 2008 before falling back in the following two years (Chart 12). The 10bn trade surplus generated by banks in net spread earnings on transactions with overseas clients accounted for over a fifth of the total 46.7bn UK trade surplus in financial services in 2011. Separate data on banks net fee income is based on gross derivatives fees receivable from foreign residents for derivatives services, netted off against fees payable. Because fee income from commission is usually included in the spread, data reported by banks to the Bank of England on their net overseas service earnings from derivatives commission is a fraction of spread earnings: such fee income fell to just 24m in 2011 from 183m in 2010. Fee income of futures and options dealers Net exports of futures and options dealers have not been separately identified in balance of payments statistics since 2002 when they totalled around 250m. Fees and commissions on exchange contracts and clearing These are significant as a majority of customers of UK exchanges and clearing organisations are based overseas or owned by overseas companies.

14 12 10 8 6 4 2 0

2004 2005 2006 2007 2008 2009 2010 2011

Source: Bank of England

Chart 13
Financial derivatives: international assets of UK nancial institutions
Financial derivatives, assets valued at end-year, bn
4000 3500 3000 2500 2000 1500 1000 500

Securities dealers* Banks

International investment position The value of financial

derivatives in the international asset position of UK financial institutions covering banks and securities dealers - recovered to 3,618bn at end2011 from 2,963bn at end-2010 (Chart 13). Previous figures based only on banks, nearly halved from a high of 4,040bn at end-2008 to 2,176bn at end-2009. Banks account for just over three quarters of financial derivatives assets - 76% in 2010 and 2011 - with the balance being made up by securities dealers.

2004 2005 2006 2007 2008 2009 2010 2011

*Securities dealers data available from 2010 Source: Ofce for National Statistics, Bank of England

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

OTHER SOURCES OF INFORMATION

Alternative Investment Management Association. www.aima.org Bank for International Settlements Triennial surveys of OTC derivatives markets International Banking and Financial Market Developments (quarterly). www.bis.org Bank of England www.bankofengland.co.uk Financial Services Authority Analysis of activity in the energy markets (annual) www.fsa.gov.uk Eurex www.eurexchange.com Futures and Options Association www.foa.co.uk Futures Industry Association www.futuresindustry.org ICE Futures Europe www.theice.com International Swaps and Derivatives Association www.isda.org LCH.Clearnet www.lchclearnet.com London Metal Exchange www.lme.com NYSE Liffe www.euronext.com/derivatives Turquoise www.tradeturquoise.com

10

www.thecityuk.com

DERIVATIVES

NOVEMBER 2012

CHARTS SHOWING BREAKDOWN OF CONTRACTS TRADED ON:

- NYSE Liffe - London Metal Exchange - ICE Futures Europe

Chart 14
NYSE Liffe
% share of contracts traded, 2011
Commodities 2% Individual equities 35% 47%

Short-term interest rate (STIRs)

13% 3% Equity index Other interest rates

Number of contracts traded in 2011: 1,149 million Source: NYSE Liffe

Chart 15
London Metal Exchange
% share of lots traded by type of metal, 2011
Tin 1% Nickel Lead 8% 6% Aluminium 43% Zinc 16% Other metals & plastics 1%

26%

Copper

Number of lots traded in 2011: 146.6 million Source: London Metal Exchange

Chart 16
ICE Futures Europe
% share of contracts traded, 2011
Natural Others 1% Emissions gas 3%2% West Texas Brent 19% 50%

25% Gas oil

Number of contracts traded in 2011: 269 million Source: ICE Futures Europe

www.thecityuk.com

11

DERIVATIVES

NOVEMBER 2012

12

www.thecityuk.com

SIGN UP FOR NEW REPORTS

if you would like to receive immediate notication by email of new thecityUk reports on the day of release please send your email address to signup@TheCityUK.com

DATAFILES
Datales in excel format for all charts and tables published in this report can be downloaded from the reports section of thecityUks website www.TheCityUK.com

THECITYUK RESEARCH
report author: Duncan mckenzie for further information about our work, or to comment on the programme/reports, please contact: Duncan mckenzie, Head of research duncan.mckenzie@TheCityUK.com, +44 (0)20 7776 8976 marko maslakovic, economic research senior manager marko.maslakovic@TheCityUK.com, +44 (0)20 7776 8977 thecityUk, 65a Basinghall street, ec2v 5DZ www.thecityUk.com copyright november 2012, thecityUk

MEMBERSHIP
to nd out more about thecityUk and the benets of membership visit www.thecityuk.com or email us at membership@thecityuk.com

this report is based upon material in possession of thecityUk limited or supplied to us, which we believe to be reliable. Whilst every effort has been made to ensure its accuracy, we cannot offer any guarantee that factual errors may not have occurred. neither thecityUk nor any ofcer or employee thereof accepts any liability or responsibility for any direct or indirect damage, consequential or other loss suffered by reason of inaccuracy or incorrectness. this publication is provided to you for information purposes and is not intended as an offer or solicitation for the purchase or sale of any nancial instrument, or as the provision of nancial advice. copyright protection exists in this publication and it may not be reproduced or published in another format by any person, for any purpose. Please cite source when quoting. all rights are reserved.