DEVELOPMENT OF DERIVATIVE MARKETS IN EMERGING MARKET COUNTRIES1 A. Background Derivatives are commonly used for managing various risk exposures, including foreign exchange, interest rate, and credit risks. By allowing investors to unbundle and transfer these risks, derivatives contribute to a more efficient allocation of capital, in many cases reduce market and portfolio volatility, facilitate cross-border capital flows, and create more opportunities for portfolio diversification. Despite rapid growth over the past several years, Emerging Market (EM) derivatives account for only about 10 percent of the total outstanding notional values in global derivatives markets. Compared to mature ...view middle of the document...
Exchange-based trading of interest rate derivatives is particularly prominent in Latin American countries (mainly Brazil and Mexico) while most of the global EM derivative trading occurs in Asia’s over-the-counter (OTC) markets (mainly Hong Kong, Korea and Singapore). At the same time, some countries in Emerging Asia record spectacular growth rates of exchange-traded equity derivative products. Equity option trading in Korea accounted for 45 and 38 percent of all EM and global exchange-based trading, respectively. Further details are provided in the Annex.
Prepared by Capital Market Development and Financial Infrastructure Division, MCM, IMF. See Global Financial Stability Report (2004).
-2Figure 1. Global Trading Volume of Exchange- and Over-the-counter (OTC) Traded Derivative Contracts (Daily averages, notional amount in billions of US dollars) ( y g )
200,000 180,000 160,000 140,000 120,000
100,000 80,000 60,000 40,000 20,000 0
LatAm EM Asia CEE/ME/ZAR LatAm EM Asia CEE/ME/ZAR LatAm EM Asia CEE/ME/ZAR
Equity Options and Futures
Interest Rate Swaps, FRAs and Options
FX Forwards and Swaps
Sources: BIS, country exchanges, ISDA, WFE, staff estimates. 1/ OTC data was obtained for the years 2001 and 2004, while data on exchange-based trading stems from annual trading activity in 2002 and 2005.
Table 1. Summary Overview of Exchange- and Over-the-counter (OTC) Trading Volume of Derivative Contracts (Daily averages, notional amount in billions of US dollars) Commodity1 98.3
Top EM Region
Interest rate 56.7
Latin America (94.7%)
Latin America (73.2%)
Top EM Region
287.7.6 OTC -
20.1 n.a. n.a.
Source: BIS Triennial Central Bank Survey (April 2004), 1/incomplete data.
-3C. Challenges and Policy Implications The state of development of the underlying asset market
Well-functioning derivative markets are generally associated with active and generally liquid underlying cash markets. The development of derivative markets in EM is hampered by problems of low liquidity levels in bond and equity markets. Limited trading activity may in turn reflect information asymmetries due to insufficient disclosure standards, lack of transparency and corporate governance related issues as well as limited participation due to entry restrictions or other distortions, including macroeconomic distortions. Liquidity in cash and derivative markets can be mutually reinforcing but at times the lack of liquidity in underlying cash markets may hamper development of derivative markets. The availability of reliable pricing benchmarks across the whole term structure helps to avoid concentration of trading at certain maturities (usually short-term), such as the case in India and Mexico. In Korea, only the...