ISDA Publishes Research Papers on Value of OTC Derivatives

ISDA published two research papers that examine the value of the over-the-counter ("OTC") derivatives market.

The first paper, titled "The Value of OTC Derivatives: Case Study Analyses of Hedges by Publicly Traded Non-Financial Firms," focuses on four case studies in which the authors consider real-world examples of OTC derivatives used by non-financial corporates, but replicate the OTC hedges with exchange-traded alternatives. The paper's conclusions include the following:

• suitable exchange-traded derivatives available to replace OTC hedges do not always exist;
• OTC hedges can be more efficient and effective than exchange-traded alternatives;
• OTC hedges can reduce earnings volatility as compared to the exchange-traded alternatives;
• mark-to-market and any potential margin requirements can impact the liquidity of non-financial firms and increase the costs of operations; and
• exchange-traded derivatives can lead to increased ineffectiveness and may not qualify potentially for Financial Accounting Standard ("FAS") 133 hedge accounting.

The second study, titled "Size and Uses of the Non-Cleared Derivatives Market," focuses specifically on the interest rate derivatives ("IRD") market and examines the scope of the non-cleared segment and the instruments it encompasses. The paper's conclusions include the following:

• the derivatives industry has made huge progress in moving toward central clearing, with 65 percent of IRD notional outstanding cleared as of year-end 2013;
• a significant portion of the IRD market currently remains non-clearable. This includes swaptions ($30 trillion in notional outstanding), cross-currency swaps ($30 trillion), options ($12 trillion) and inflation swaps ($3 trillion). An additional $8 trillion of the IRD market comprises transactions in products that are available for clearing, but in currencies that can't be cleared; and
• non-clearable derivatives have an important social value; they are widely used by corporates, pension funds, insurance companies and retail banks for important risk management purposes. Without non-clearable derivatives, users of these products may experience greater earnings volatility due to an inability to qualify for hedge accounting, or be unable to offset the interest rate, inflation and longevity risks posed by long-dated pension or insurance liabilities.

See: The Value of OTC Derivatives: Case Study Analyses of Hedges by Publicly Traded Non-Financial Firms; Size and Uses of the Non-Cleared Derivatives Market; ISDA Press Release.