So much has happened in derivative markets in the past year, and so many public statements have been made, demanding that the market move in this or that direction, that it is easy to lose sight of what has actually changed, and what has remained the same.

In particular, there are marked contrasts in the ways different sectors of the derivatives market have behaved. Not everything has been harmed – metals derivative volumes, for example, have risen – and while the regulatory spotlight is getting some market participants hot under the collar, other asset classes have remained very much in the background.

The three main areas of change and attention are energy, agricultural products and credit default swaps. These have been targeted by politicians because of public outcry and interesting reactions from the market have ensued.

Energy: tough talking

Energy market regulation was on the cards even before the big crash in September 2008, but the dramatic drop in the oil price, coupled with politicians’ attention being turned to the system as a whole rather than particular areas, gave oil market participants a breathing space.

But a year later, we are once again in the midst of a contentious debate spanning the globe, about what role speculation has played so far, and what role it ought to play in the future.

The US Commodity Futures Trading Commission held three days of consultations in late July and early August, during which representatives of non-commercial and commercial market participants testified.

In his opening statement, CFTC chairman Gary Gensler said: “While speculators are essential participants, Congress long ago realised that there may be burdens to the economy when the market becomes too concentrated.”

Now the CFTC is in the process of deciding whether to impose mandatory position limits on speculators in energy commodity derivatives.

At present the CFTC has this power but does not exercise it, delegating authority to the regulated exchanges to set their own limits on participants in their markets.

Many expect that the CFTC will take the reins more firmly. Gensler said in a statement on September 16: “I believe that we should seriously consider the benefits of position limits.” The market waits with bated breath, and sources close to the CFTC suggest a decision will be made this autumn.

In August 2009, the CFTC and the UK Financial Services Authority agreed to cooperate more and enhance cross-border surveillance. On September 15, the two regulators signed a memorandum of understanding to “enhance cooperation and the exchange of information relating to the supervision of cross-border clearing organisations”.

The US regulator told ICE Futures Europe – based in London and UK-regulated, though American-owned – it had to provide more data on trades if it wanted to keep its no-action letter.

It must provide an audit data trail for the CFTC’s Trade Surveillance System and show CFTC staff advance copies of all rule amendments and disciplinary notices. The CFTC maintains that it has the same authority to impose emergency powers on ICE’s West Texas Intermediate oil contract as it has on the equivalent at Nymex.

While this sounds like something ICE would hate, the parent ICE group in the US has supported the idea of the CFTC setting position limits rather than another body doing it.

The main reason is that ICE is afraid that a system of position limits based on forbidding any firm to exceed a certain percentage of one exchange’s volume would trap smaller exchanges like itself forever in the shadow of CME Group, because no one would be allowed to use ICE to build a big position.

It therefore favours position limits for each firm that are marketwide, uniting all positions in any trading venue.

One of the principal arguments against mandatory position limits is that trading could migrate offshore.

Marc Cornelius, a senior advisor on policy and regulation, integrated supply and trading at BP, said at an Isda conference panel that regulatory pressure on US-linked contracts could lead to developments in other contracts, for example those in Dubai. But the Dubai Mercantile Exchange’s Oman oil contract is subject to CFTC regulation, so it is unclear whether such activity is likely to take place.

Carbon: what recession?

Carbon derivative trading has grown phenomenally despite the recession, and is likely to continue to rise. This growth will be both organic (increasing liquidity attracting more institutional investors) and politically imposed (more industries are set to join the European Emissions Trading Scheme and the US Waxman-Markey Bill has already been passed by the House of Representatives and is now in the hands of the Senate).

President Obama has committed to cap-and-trade in his election manifesto so it is likely that a national US carbon market will be introduced in the next few years.

Indeed, the US market participants are already anticipating this by trading more and more carbon derivatives. On the Chicago Climate Futures Exchange, the volume of Regional Greenhouse Gas Initiative futures – those based on a mandatory CO2 cap-and-trade market in 10 northeastern and Mid-Atlantic states – has soared this year, from a small portion of the exchange’s business as recently as February to the bulk of it in June and July.

And trading of the European Climate Exchange’s flagship EU Allowance contract swelled by 126% between the period from September 2007 to August 2008 and the same period a year later.

The market is now waiting for December’s UN climate change summit in Copenhagen, where crucial decisions about environmental policy will be made. More countries might introduce cap-and-trade schemes.

One problem to be addressed is the standardisation of Carbon Emissions Reduction (CER) certificates, which are part of the UN’s Clean Development Mechanism. The certificates are awarded for projects in the developing world that reduce emissions. They can be used in the EU by polluters that want to emit more than their permitted CO2.

But there is ambiguity about which projects will be eligible for CERs in the third stage of the EU Emissions Trading Scheme, which starts in 2012. Clarity on this issue should help futures markets.

Credit: getting its house in order – or pretending to

Credit default swaps have suffered from both market pressure and political lobbying over the past year. But the decline in their volumes may have little to do with either. The market’s breakthroughs in late 2008 in compressing trades did much more to reduce the notional principal outstanding.

According to a survey by the International Swaps and Derivatives Association (Isda), the notional value of credit derivatives fell 19% in the first six months of 2009 from $38.6tr to $31.2tr. Year-on-year, the total fell 43% year-on-year from $54.6tr in mid-2008.

Yet Stuart Wain, head of financial institutions credit trading at JP Morgan in London, argued at the same panel that liquidity in the credit market has been steadily rising since the initial crash a year ago. Customer demand has changed, though. There is less cross-border investment, Wain observes, and it is harder to sell contracts on small companies outside the region they are based in.

In the US, the ‘Big Bang protocol’, otherwise known as the Credit Derivatives Determinations Committees and Auction Settlement CDS Protocol, was published on March 12. Over 2,000 trading parties signed up to the protocol to standardise credit derivatives.

Mayur Jethwa, head of European credit trading at Bank of America Merrill Lynch, said that: “Standardisation has already led to an increase in flow in some areas.” An example is increased arbitrage between different indices.

Politicians homed in on credit derivatives soon after dealing with the initial bailout packages for firms like insurer AIG, which had a huge book of them and had to be rescued because of the derivatives counterparty risk it posed for so many other financial firms, at a time of near-panic in the markets.

Since then the market has been pressurised into adopting central clearing for some contracts. Liffe in Europe was there first in late December 2008 but the market spurned its offering, for reasons that few will talk about. Many suspect, however, that the main reason is that the leading brokers have invested capital in ICE’s solution.

So CDS clearing began in the US with ICE Trust on March 9. In the next six months ICE cleared more than 24,000 transactions, totalling over $2tr. And these are just CDX index trades – single name CDS are still in the works. No rival has cleared any US business yet.

EU commissioner Charlie McCreevy initially threatened to mandate central clearing of CDS but then came to an agreement with Isda and the European Banking Federation in February.

CDS dealers promised to start using an EU-based central counterparty for a lot (precisely how much was not specified) of their CDS on European companies from July. Many politicians and regulators have publicly accepted that some CDS may not be suitable for clearing, although again, the reasons for this remain obscure. Some market participants admit privately that the vast majority of the market could be cleared.

Before central clearing of CDS started in Europe, concerns were raised that an EU-led solution might lead to business being conducted in the euro zone, putting London at a disadvantage.

George Osborne, Britain’s shadow chancellor of the exchequer, published a white paper on financial regulation in July called ‘From crisis to confidence: Plan for sound banking’.

It addressed the issue of European clearing and said: “As the global centre of much of this activity, London must be the home of any European clearing house for derivatives, and a Conservative government will fight to make sure that it is.” The paper supported “greater central counterparty clearing” and “a more appropriate balance between exchange-traded and over-the-counter securities”.

But so far there is little for Osborne to fear. London-based ICE Clear Europe cleared almost $450bn of European CDS between opening for business on July 29 and September 11. By early September, Frankfurt’s Eurex had managed just 10 trades worth Eu90m – although one was a single name contract on German utility RWE.

CME is still determined to field a European solution and has recently appointed Andrew Lamb to lead its UK-based clearing house.

Metals: still an Asian story

Metal derivatives have bucked the downward trend but this is mainly because of just one remarkable contract – the Shanghai Futures Exchange’s Steel Rebar Future, which was only introduced on March 27.

Its volume in August 2009 reached a daily average of 1,252,455, or 12.5m tonnes of steel – well above the total of steel produced globally on an average day. This one contract accounted for nearly half of the world’s exchange-traded metal derivatives throughput in that month.

The Shanghai Futures Exchange’s Copper Cathode Future has also grown strongly in the past year. It grew month after month between October 2008 and March 2009, though it has levelled off since.

In Europe, where the vast majority of metals volume comes from the London Metals Exchange, volumes have not been affected by the downturn. The proportion of volume in each contract has remained remarkably similar over the past two years, in spite of economic tumult.

Pricing is a different story. Copper Futures at Nymex’s Comex division fell from over $300 in late September 2008 to below $150 in early December. They have been in steady recovery since January and are now back to nearly $300 again.

Precious metals have had a particularly exciting year. The price of gold dropped off a cliff in September 2008 but quickly began to recover and headed on an upward trajectory from mid-December. Volumes of the Comex gold future have fallen year-on-year, however.

Interest rates: short term pain

Exchange-traded interest rate futures and options have been the biggest crisis victims in the listed derivatives world, with volume 29% down from a daily average of 171.55m contracts from September 2007 to August 2008 to 121.78m in the following 12 months.

There are several reasons why interest rate derivatives may have been disproportionately affected, though no one knows for sure.

First, they made up a large proportion of all exchange-traded derivatives before the crisis, so they attracted large institutions and those looking for high liquidity. Such firms were the ones most affected in the early stages of the crisis, so their deleveraging had a dramatic effect on interest rate volumes.

A second argument is that volumes were also affected by reduced activity in the underlying bond market, such as new issuance, leading to fewer interest rate derivatives being used to hedge. The weakness of this argument is that the interruptions in private sector bond issuance were patchy and short-lived, while government bonds have enjoyed a simultaneous price rally and boom in issuance.

A stronger theory may be that the crisis made the future direction of interest rates fairly obvious, reducing the need to hedge. It was pretty clear in most countries, first that rates were coming down, then that they had hit bottom, and now that they are likely to stay there for some time.

Another reason for loss of interest in bond futures could be that the pricing of different countries’ government bonds has diverged sharply as the crisis has put national finances under pressure to varying degrees.

Italian bonds, for example, trade at a much higher spread over German Bunds than they used to. This is entirely to be expected and does not mean the weaker countries are in any serious danger of default. But it does mean the standard benchmark interest rate derivatives such as Eurex’s Bund, Bobl and Schatz futures on German federal debt may no longer be as suitable for hedging the weaker bonds. This was the argument Eurex advanced when it introduced futures on BTPs – Italian government bonds – in September 2009.

According to Isda, the total notional amount of outstanding interest rate derivatives including swaps, options and cross-currency swaps fell 11% from mid-2008 to mid-2009 and is now $414tr.

Agriculture: a mixed harvest

Agricultural derivatives volumes have not dwindled much in trading volume in the past year, but their month-on-month fluctuation is much more pronounced than it was a year ago.

Driving this fluctuation is volume on China’s Dalian Commodity Exchange and Zhengzhou Commodity Exchange. Some contracts have swelled month-on-month – such as DCE’s No 1 Soybeans Future and Crude Soybean Oil Future. Others have trended down – the Soymeal and Corn Futures at DCE and ZCE’s Strong Gluten Wheat Future.

Meanwhile, there has been contention in the US over speculation in agricultural commodities, offering many parallels with the oil market debate. Senator Carl Levin’s report ‘Excessive speculation in the wheat market’, published in June 2009, found that index traders “increased futures prices relative to cash prices”.

Gensler said then that the CFTC was seriously considering the committee’s recommendation to phase out existing waivers for index traders.

In August 2009, the CFTC withdrew the no-action letters exempting two funds, Deutsche Bank’s DB Commodity Index Tracking Master Fund and Gresham Investment Management, from speculative positions limits for soy, wheat and corn futures.

Volume in the Chicago Board Of Trade wheat futures has not changed drastically year-on-year in spite of this.

Ethanol is becoming increasingly popular as a biofuel and volumes in the CBOT Denatured Fuel Ethanol Future have been rising since last September. The equivalent option has fared less well and volumes have fallen.

Equity: steady as she goes

Exchange-traded equity derivatives have traded more actively this year than last. For September 2008 to August 2009, volumes were 35% higher than the same period a year before. This increase is mainly due to an extraordinary throughput in September 2008, when an average daily volume of 21.27m contracts were traded, up from just 5.46m the year before. When this is taken out of the equation, volumes still grew, but by a more modest 5%.

“We will see more equity derivatives products being available in listed form,” said Rachel Lord, head of sales and distribution for EMEA derivatives at Citigroup, at the Isda event. “We will also see more standardised products and a broadening of single name underlyings.” She added that the market needed a greater breadth of maturities.

Currencies: down but not out

The foreign exchange market seems to have resisted the move to exchange-based central counterparty clearing more than other asset classes. This may be because of the widespread preference for CLS Settlement, which is owned by foreign exchange market participants. Just over half of foreign exchange obligations go through CLS.

Volumes of exchange-traded FX products have fallen 14% year-on-year. Trading on the Moscow Interbank Currency Exchange fell drastically from October to November 2008 and volume in August 2009 was just 52,600 contracts a day, 93% less than a year ago.

“We don’t really see exchange-cleared in the future… we have a solution,” says Joachim Alpen, global head of foreign exchange at SEB in Stockholm: “That banks would be prepared to pay for another settlement system is highly unlikely.” He does say, however, that exchanges have a chance to perform more clearing for the FX market. “It boils down to effective collateral management,” he says.

Exchanges: the wealth gap

Some exchanges have performed relatively well in the past year. A good basis for comparison is the ranking of exchanges according to year to date volume. On this basis, as of the end of July 2009, the Shanghai Futures Exchange had climbed from 29th to 15th place, on a volume rise of 207.2%.

Futures and Options on the Russian Trading System rose from 16th to 11th with volume up 73.52%, while Nyse Arca options rose from 17th to 12th, though its volume declined by 9.1%.

Some exchanges dropped a few places. CBOT’s ranking fell from 5th to 8th as volume slumped by 39.7%. Nasdaq OMX slipped from 20th to 25th as volume declined 28.8%. Moscow Interbank Currency Exchange shrank by 83.7%, taking it from 26th to 44th.

Another measure of performance is MondoVisione’s exchange index, which lists the capital return in dollars on the shares in the main listed exchanges.

Based on this, Brazil’s BM&F Bovespa was a high flyer, up 140.7% year-to-date at the end of August 2009. The Johannesburg Stock Exchange grew by 97.7% on the same basis. Nasdaq OMX was the only exchange on the index that fell on this basis, down 11.2%.