The over-the-counter (OTC) derivatives market is a cornerstone of the global financial system, enabling corporations, governments and financial institutions around the world to manage risk, enhance returns, optimize liquidity and efficiently allocate capital. This creates value for users by fostering predictability, reducing costs, protecting against losses and dampening the impact of volatility on earnings – in turn, generating value for the broader economy by bringing greater stability and giving companies the confidence to borrow, invest and hire.

Essential Role in Global Finance

• OTC derivatives act as a foundational layer in modern financial markets, allowing firms to tailor solutions for specific risks, bringing certainty and stability to their operations and enhancing value.
• They are used in advanced economies and emerging markets alike, helping to stabilize operations, manage growth and maintain financial resilience, creating economic value.

High Adoption Across Sectors

A review of 1,187 companies in seven major stock indices shows 87.1% use OTC derivatives, indicating near-universal acceptance of these instruments and the value they bring.

• Both financial and non-financial entities embrace derivatives to hedge risks tied to interest rates, currencies, commodities, equities and credit and to optimize returns, reflecting their flexibility and practicality.

Industry-specific Applications

• Manufacturers: Use interest rate and currency swaps to lock in predictable debt costs, safeguarding profitability against rate hikes and giving firms the confidence to borrow and invest.
• Exporters: Manage foreign exchange (FX) swings with forwards and options, ensuring stable conversion rates when receiving overseas revenues and preserving value even during unpredictable FX markets.
• Food Producers: Smooth out volatile crop prices through futures and forwards, which can help sustain farmer incomes and bring value to consumers by helping to control prices.
• Energy Producers/Distributors: Hedge oil, gas or electricity price risks, protecting consumers from severe price spikes and stabilizing operating budgets.
• Asset Managers: Use swaps, options and other derivatives to balance portfolio exposures, enhance returns and protect against market downturns, creating value for investors by preserving and creating wealth.
• Pension Funds: Employ swaps and other derivatives to shield retirement assets from shifts in interest rates, inflation and equity markets and to augment returns, bringing value to retirees by preserving long-term pension payouts.
• Insurance Companies: Use a variety of derivatives to mitigate interest rate, inflation and equity risks, and efficiently adjust and optimize their risk profile, ensuring sufficient reserves to pay out future claims and maintain solvency.
• Banks: Hedge interest rate mismatches between deposits and loans, maintaining lending capacity and strengthening balance sheets, enabling them to continue to lend and provide value to the real economy.
• Mortgage Providers: Manage interest rate and prepayment risks to keep home financing widely accessible, supporting efficient and stable housing markets and allowing individuals to borrow cost-effectively.

Key Benefits and Broader Impact

• Risk Mitigation and Certainty: Derivatives can reduce earnings volatility and lock in financing terms, enhancing company value and enabling entities to plan confidently and make strategic investments.
• Enhanced Capital Allocation: By transferring or offsetting specific risks, firms can redeploy savings into new projects, fostering investment and business expansion.
• Support for Economic Growth: Stable corporate operations and improved access to funding lead to increased hiring, stronger investment pipelines and broader market development, contributing to economic value.
• Efficient Market Functioning: Hedgers and investors collectively contribute to deeper liquidity, tighter spreads and more accurate price discovery, benefiting all market participants.

Derivatives help firms mitigate risk, enhance certainty and stability, reduce costs, dampen the impact of market volatility and enhance financial performance and company value. This ultimately contributes to investment, job creation and economic growth.

Click on the PDF to read the full report.