A new survey from Fitch Ratings shows a huge increase in the global credit derivatives market in 2003 from 2002.

The New York-based rating agency found that the market expanded to US$2.8 trillion, measured by gross sold outstanding derivatives. This rises to US$3.0 trillion if cash collateralized debt obligations are included. This represents an increase of 71% from US$1.7 trillion (US$1.8 trillion including cash CDOs) last year.

Single-name credit default swaps experienced the largest growth, increasing 100% to $1.9 trillion. Portfolio products, including the traded indices, were up 49%, totaling $754 billion.

Fitch says that hedge fund activity in this market grew substantially year-over-year, and these funds now comprises between 20% and 30% of CDS volume for a number of market intermediaries. Their prominence has potential implications in terms of event risk, liquidity and price volatility, it says.

The firm also reported that global banks remained net buyers of derivatives, although individual firms showed significant swings in net positions. Many banks and broker-dealers shifted from net buyers to net sellers. Many firms are actively trading these products, rather than simply using them for credit risk management. Firms in the global insurance sector continued to get out of this market, Fitch said.

“An important development among the [credit derivatives] dealer community (global securities firms and banks) has been the advent of dynamic hedging risk management strategies and a significant increase in ‘correlation trading.’ The ability to retain, model and dynamically hedge large corporate reference portfolios has supplanted the need to hedge every position by purchasing protection from another counterparty,” it says.

The top five counterparties in this market are JP Morgan, Deutsche Bank, Goldman Sachs, Morgan Stanley and Merrill Lynch, Fitch says. TD Bank was the only Canadian firm among the top 25, although it ranked 19th, down from 11th spot the prior year. Royal Bank, 16th last year, and CIBC, which ranked 21st, both dropped out of the top 25.

Meanwhile, the ratings quality for the credit derivatives market declined, Fitcht said, as below investment-grade and unrated exposures increased to 18% from 8% last year, reflecting lower demand for protection and increased trading flows involving high-yield credits.