Efforts to mitigate risk are paying off

The resounding theme of events in the past week is that more needs to be done to mitigate operational risk. That said, many steps have been made in the wider market...

A survey of banks and institutional investors released by the International Swaps and Derivatives Association last week (April 22) confirmed the sharp rise in the use of collateral as a risk mitigation tool last year in the wake of the worsening financial crisis. Over-the-counter derivatives traders have increased their use of collateral by 86% in the past year, with an estimated $4 trillion of collateral in circulation at the end of 2008, up from $2.1 trillion at the end of 2007. Cash represented 84% of collateral received and 83% of collateral delivered.

"Isda's margin survey indicates that, amid the volatility in the financial markets, collateral management programmes continue to expand, covering increased trade volumes and credit exposures," said Robert Pickel, executive director and chief executive at Isda, in the report.

The survey estimates more than 150,000 collateral agreements are now in place and respondents predict growth of 26% in 2009.

Similarly, as reported by Risk News, multilateral tear-up efforts continue to work, with notional outstanding reduced by several trillion dollars, according to the industry body. Isda said trading in interest rate derivatives "remains solid", but portfolio compression efforts meant notional outstanding had fallen to $403.1 trillion by the end of 2008, down from $464.7 trillion at the end of June. Credit default swaps saw a similar decline, with notional outstanding falling from $54.6 trillion to $38.6 trillion by the end of last year. Equity derivatives, a smaller market, fell from $11.9 trillion to $8.7 trillion outstanding.

Isda estimated that, at the end of 2008, derivatives holders had a net total credit exposure of $2.7 trillion.

The latest figures represent success for Isda and other market participants in their efforts to reduce notional outstandings by tearing up offsetting trades. The second half of 2008 saw interest rates outstanding, by far the largest market, fall for the first time. Outstanding credit default swaps (CDS) notional continued to fall, after dropping in the first half of 2008 for the first time in the market's history.

Isda's changes to CDS contracts, which came into force earlier this month, are expected to increase tear-up activity further in the CDS market.

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