1. OTC Derivatives: Trading, Reporting & Regulations
Udaipur
8th Jan 2011

2. Introduction OTC Derivatives Foreign Currency Credit Equity/ Commodity
The family of OTC derivatives includes is classified by asset class - Interest Rate, FX, Credit, Equity and Commodity derivatives.
OTC
Derivatives
Foreign Currency
Credit
Equity/ Commodity
Interest Rate

3. Background
Includes the gamut of Interest Rate, FX, Credit and Currency Derivatives
Primarily plain vanilla products involving currencies or interest rates
Interest Rate Derivatives is the largest subset with Swaps predominating
A gradual shift from OTC to exchange traded products
Fragmented Markets vs Concentrated Markets
On line Trade reporting for Rupee IRS since 2007 has massively improved transparency and price discovery
Initiatives underway around trade reporting and central clearing of all OTC products 3

4. Global Context
20% CAGR from 1995 in the use of Interest Rate and Currency Derivatives
70% growth in the use of Credit Derivatives since inception
Current Estimated Outstanding
$400 Tn in Interest Rate and Currency Derivatives
$ 65 Tn in Credit Derivatives
$ 10 Tn in Equity Derivative
Daily Estmated Turnover
$1.7 Tn in Interest Rate Derivatives
$0.3 Tn in Currency Derivatives
Credit derivatives - heavily in the news due to the sub-prime crisis

5. Domestic Context Plain Vanilla IRS introduced in 1999
Currency Forwards in existence for long, FX Options introduced in 2005
Credit Derivatives, currently not allowed but in advanced discussion stage
Equity and commodity derivatives due to the nature of their underlying markets have moved to exchanges
Current Outstanding
Rs 46 lac crore in Interest Rate Derivatives
Rs 36 lac crore in Currency Derivatives

6. Products Interest Rate Derivatives include IRS, FRAs
The IRS dealt include OIS, INBMK, MIFOR
Currency Derivatives include the basic FX forwards, Swaps and Options
Credit Derivatives (CDS) currently disallowed but in the process of being introduced with appropriate safeguards 6

7. Interest Rate Derivatives
Introduced in 1999 and has seen immense growth and popularity
Gross Outstanding contracts in the region of Rs21 lac cr; however net is much lower
Daily volumes in the region of Rs10,000cr
In recent times has acted as useful hedge for interest rate risk
Key applications include short term asset management and duration management
Participation remains essentially foreign bank skewed
Local banks can play a key role in balancing the market interest and closing the existing arbitrages 7

8. Interest Rate Derivatives - Benchmarks
OIS
MIFOR
INBMK
Overnight inter bank call money rate
Most Liquid - Average Daily Volume INR 200 bio
Liquid Up to 5 years
Implied rupee interest rate derived from USD vs INR forward rates.
Hedge for Currency swap positions with clients
Benchmark is the 1 year GOI yield
Used primarily for duration management of bond portfolios

9. Currency Derivatives
Gradual evolution from forwards to matched swaps to position taking
FX Forwards represent the largest portion of this segment
FX Options allowed in 2005 has tremendously benefited corporate wishing to put on shorter term hedges
Underlying exposure continues to be a key requirement to ensure orderly markets
Latest guidelines issued Dec 28th 9

10. Key Issues in OTC Derivatives
Established Client need - customized solutions, hedge effectiveness
OTC markets criticized for being opaque, but are the largest component of world financial markets
3 decades history
Participants are large, professional institutions mostly banks hence regulated
Transparency to regulators versus transparency to all
Capital charge on counterparty exposures and for market risk
Reporting required for MTM, systemic stability, regulatory information
Trade compression, focus on net risk or open interest
Price impact of post-trade dissemination 10

11. Transparency Pre-trade transparency Interbank quotes
Single screen offering
Composite levels
Post-trade transparency
Trade repository
Confirmations
Payment advice
Collateral management
Valuation 11

12. Road Ahead for OTC Derivatives
Standardized contracts
Trade repository
Central Clearing
Electronic Trading system, anonymous order matching
Review of Capital charges
Post trade services
New Products (swaptions, caps/ floors) to be introduced in a phased manner 12