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October 14th, 2010  
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podcast  The Next Crisis : Interest Rate Derivatives (Jim Puplava - FinancialSense)

Over-the-counter (OTC) derivatives markets

Global Positions end-June 2010 ( BIS)

In the first half of 2010, growth in amounts outstanding was subdued or negative in all risk categories. Positions of all types of OTC derivatives fell by 4% to $583 trillion (10 times the world’s GDP).  
 
Today the BIS releases the latest statistics on positions in the global over-the-counter (OTC) derivatives market. These comprise the results of the second part of the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity as well as the regular semiannual OTC derivatives statistics.
  Over-the-Counter-derivatives
     * Positions in the OTC derivatives market went up in the three years since the last Triennial survey (+15%, or 5% annualized) to $583 trillion, but at a slower pace than during the previous period from 2004 to 2007 (+ 131%, or 32% per year). Data from the semiannual survey shows that the modest overall increase is the result of a surge in positions until June 2008, followed by a decline in the wake of the financial crisis. Growth in gross market values, which provide a measure of the counterparty risk of these positions at prevailing market prices, increased far more than notional amounts outstanding, going up by 122% to $25 trillion at the end of June 2010 . This compares to a growth of 74% during the previous (2004-07) reporting period.
 
     * The modest overall growth in notional amounts outstanding hides significant variations across risk categories. The highest growth was recorded in the interest rate segment of the OTC derivatives (25%), bringing the share of this risk category in the market total to 82%. Positions in foreign exchange derivatives went up by 9%. By contrast, amounts outstanding of the other OTC segments declined substantially, ranging from 30% and 40% (equity and credit) to 60% (commodity contracts). Sharp movements in asset prices, related to a reassessment of risks during the financial crisis, drove up gross market values of foreign exchange (100%), credit (88%) and interest rate derivatives (175%). Gross market values of equity and commodity contracts declined.
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    * Data from the semiannual survey shows that, in the first half of 2010, growth in amounts outstanding was subdued or negative in all risk categories. Positions of all types of OTC derivatives fell by 4% to $583 trillion, following the 2% increase in the second half of 2009. The decline occurred against the backdrop of deteriorating market sentiment related to the European sovereign debt crisis. However, much of the contraction reflected a valuation effect due to the depreciation of European currencies against the US dollar, the currency in which the data are reported. In contrast to the decline in the positions, gross market values for existing OTC contracts rose by 15% to $25 trillion at end-June on the back of sharp asset price movements. Gross credit exposures, after netting agreements, which had dropped slightly in the half-year up to end-2009 (-6%) increased by 2% to $3.6 trillion.
  
 
* Notional amounts outstanding of credit default swaps (CDS) declined for the fifth consecutive semiannual period, largely due to terminations of existing contracts. Gross market values for single-name contracts dropped by 16%, while those for multi-name contracts rose by 10%. The latest semiannual survey introduces additional information on the importance of central counterparties (CCPs) in the CDS market. At end-June 2010, about 11% of CDS positions were vis-à-vis a CCP 1 .
 
The CDS counterparty breakdown for contracts with other financial institutions has also been expanded. In particular, special purpose vehicles (SPVs) and hedge funds are singled out for the first time. CDS contracts with hedge funds and SPVs account for about 5% and 4% respectively of total notional amounts outstanding with other financial institutions.
 
A detailed analysis of elements of the 2010 Triennial Survey and of the end June 2010 semiannual OTC derivatives statistics will be made available in the forthcoming December BIS Quarterly Review. In particular, the publication will include special features on structural changes in the CDS market, on derivatives in the emerging economies, on the drivers of growth in FX markets, and a user's guide to the Triennial survey.


EU unveils crackdown on derivatives  FT
 
The rules being proposed by the Commission will need approval both from EU member states and the European parliament. The aim is to have them in force by mid to late 2012.
 
The proposals follow agreement by G20 leaders last year to standardise derivatives trading and move them on to exchanges or electronic trading platforms where appropriate. The proposals will closely align the EU with the new regime that is coming into force in the US.
 
The rules will require standard OTC derivatives to be processed through clearing houses – a move aimed at reducing systemic risk arising from a default of one party in an OTC deal. They will also require OTC contracts – the bilateral agreements between buyers and sellers – to be reported to “trade repositories” or data banks, and for this information to be available to regulators.
 
But Brussels also plans to make it more expensive for firms to deal in non-cleared contracts, by requiring them to hold more capital against these – although that measure will be introduced in separate legislation shortly.
 
The short-selling proposals suggest that investors must disclose significant net short positions to regulators once these amount to 0.2 per cent of the issued share capital of a company, and to the market at a higher 0.5 per cent threshold.
 
So-called “naked” short selling – where traders sell a security without owning it or borrowing it in expectation of buying it back at a cheaper level – will only be allowed in limited circumstances.
 
There will be a specific regime for telling regulators about significant net short positions in credit default swap positions related to EU sovereign debt issuers. The proposals also include powers to allow national regulators to restrict short selling in sovereign CDSs during periods of volatile trading
 
Hospitals Claim Wall Street Wounds  WSJ

Hospitals that made wrong-way "swaps" and auction-rate bets are blaming Wall Street. The Street says the hospitals had reaped millions of dollars in savings before the market turned sour. Some hospitals are paying millions of dollars in penalties to get out of derivatives contracts, after betting incorrectly that interest rates would rise. Other hospitals are paying higher interest rates. At many, these ill-fated financial bets have contributed to layoffs and scuttled projects.
 
More than 500 nonprofit hospitals—at least one in six—bought interest-rate "swaps" in a bid to lower their borrowing costs, estimates Municipal Market Advisors, a Concord, Mass., consulting firm. The swaps allowed hospitals to act much like homeowners switching from a floating-rate mortgage to fixed-rate one, betting on rising interest rates.
 
For a fee, the hospitals received a fixed rate to sell bonds, lower than the municipal-bond market at the time. These bets backfired when the Federal Reserve cut interest rates to nearly zero from more than 5% in 2007.
 
Hospitals also issued auction-rate securities—which reset bond prices weekly or monthly through auctions—that represented about a third of the $330 billion market for these derivatives.
 
Hospitals paid Wall Street firms more than $120 million in fees for the securities between 2005 and 2007, said data firm Thomson Reuters. That market dried in the 2008 financial panic, leaving hospitals with higher interest rates.   Wall Street firms and many hospital executives say interest-rate swaps were a plain-vanilla product that they have sold for years and say no one could have foreseen the crisis that cratered the auction-rate securities market. "For years and years it was a smart strategy," said Richard Clarke, president of Healthcare Financial Management Association, a trade group. "Hospitals made money on these for a long time."
 
The hospital deals were part of a larger stampede into swaps contracts by cities, schools and other taxing districts seeking to lower their payments on bonds they sold. Some strapped hospitals only now are beginning to break the contracts and pay a financial penalty for it.
 
Swaps were "the Edsel of the time," said John Hackbarth Jr., chief financial officer of Owensboro Medical Health System of Kentucky, which recently paid about $14 million to end an interest-rate swap with Merrill Lynch, now part of Bank of America Corp.

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