Happy 40th Birthday ISDA – on its notable anniversary, we consider its recent report into The Uses and Value of Derivatives
Introduction
As part of its 40th anniversary celebrations ISDA has published a new report on how the uses and value of derivatives have developed during its 40-year history.
Those of us with long enough memories will remember what a fast-moving, innovative and exciting time it was in those early years, when we wrestled with understanding and monitoring the array of often quite-exotic derivative products - frequently developed, marketed and launched at ever-increasing speed by the global investment banks.
History
In the year after ISDA was formed, regulators were still trying to get to grips with the rapid changes that were occurring in their markets so the Bank for International Settlements (BIS) formed a Study Group and gave them a helping hand by publishing a 270-page book in 1986 entitled ‘Recent Innovations in International Banking’. This provided an in-depth user manual for the Central Banks on such new and mystifying products as note issuance facilities; currency and interest rate swaps involving streams of interest payments; foreign currency and interest rate options and forward rate agreements.
Where we are now
Fast forward 40 years and the use of these instruments has become common place across the financial and non financial worlds. ISDA’s report, produced in conjunction with the Boston Consulting Group (BCG), shows how extensive that take-up has been over the past four decades. It also explores how and why different types of firms use different types of derivatives, the value these instruments bring to their business and the benefits to the broader economy.
The BCG analysed 1,187 companies listed on seven major equity indices and found that 87.1% of them use OTC derivatives to manage their business, indicating near-universal acceptance of these instruments. Both financial and non-financial entities embrace derivatives to hedge risks (tied to interest rates, currencies, commodities, equities and credit), to add value and to optimise returns, clearly reflecting the tremendous flexibility and practical application of derivatives.
A wider BIS study of over 80,000 financial statements from more than 14,000 companies showed those using derivatives to manage interest rate risk on their variable rate debt experienced smaller declines in equity value after a 100-basis point hike rise in rates; and a survey of more than 2,000 firms in Asia-Pacific showed that firms that used derivatives cut losses due to currency volatility by 75%.
A further study of 2,718 loan contracts from 1,185 firms, showed that companies using derivatives were able to boost investment spending by about 13% of the sample’s average investment level and pay lower interest rate loan spreads by around 29%.
ISDA’s report shows that OTC derivatives have been extensively used by a wide variety of entities around the globe over the past 40 years, from agricultural companies to banks to governments, to transfer risks, create certainty and stability and enhance returns, and that derivative markets contribute to vibrant, competitive, robust and liquid financial markets, ultimately promoting economic growth. To quote ISDA’s CEO, Scott O’Malia, ‘derivatives play a very strategic role in managing risk and in the creation and preservation of wealth.’
This is a brief summary of ISDA’s very comprehensive and in-depth factual report and their 115-pagereport can be found on their website, www.isda.org. It is highly recommended reading for those who are interested in the development, usage and reach of derivatives within the global economy and notably for those who are in the early stages of their financial career.
For those who have more practical needs FMCR has extensive first-hand experience in the derivatives space, from the trading floor to the C-suite, and we are always willing to provide our expertise to help solve clients’ problems.
In the first instance please contact FMCR at contact@fmcr.com.