Derivatives were first instruments developed to secure the supply of commodities and facilitate trade. In Ancient Mesopotamia, with a view to encouraging trade and securing the supply of commodities, both in time and geographical distance, the rulers’ codes actually required that purchases, sales and other commercial agreements be in written form in order to provide buyers and sellers with the greatest possible legal certainty to engage in trade. The purpose was to minimise the “your word against mine” maxim in case of disputes.
Merchants of the city-states of the region thus developed, in addition to the codes, commercial contracts. Records of such contracts have been found in cuneiform script on clay tablets. Some types of contracts were arrangements on the future delivery of grain that stipulated for instance before planting that a seller would deliver a certain quantity of grain for a price paid at the time of contracting. Such types of contracts not only dealt with grain but also with all sorts of commodities. Some of the contracts were “bearer” securities that could be transferred to third parties maturity. These types of contracts had the features of today’s forwards and were used across borders. By about 1,400 BC, cuneiform script in the Babylonian language was even used in Egypt to record transactions with Crete, Cyprus, the Aegean Islands, Assyria and the Hittites. During the Ancient Mesopotamian period, derivatives contained, most of the time, a description of the parties, a description of the asset to be transferred, the price of the transaction, the date of delivery and sometimes a list and even a description of witnesses.
Trading took place at the gates of the cities, at the quaysides in port cities and in the city centres, more precisely at the temples. In addition to their religious, political and military functions, the temples played a significant commercial role. They were directly and indirectly involved in trade and as a consequence in derivatives transactions. They functioned as trade repositories, were parties to contracts and offered warehouse facilities. They also provided quantity and quality measurement standards. Some functions of central clearing already appeared in Ancient Mesopotamia where temples operated as clearinghouses. Long-distance trade, including derivatives was regulated and supervised by the government.
In the Middle Ages, derivatives continued to be an instrument facilitating trade. One early example of derivatives is a form of commanda which was used by Italian merchants from the 10th century on. Commandas were a kind of commercial partnership contract for sea or land ventures. One partner put up the money, whereas the other travelled on the venture. Many of these contracts could be considered as commodity forward contracts, as in exchange of the invested capital, the “venturer” agreed to acquire specified commodities.
An early form of markets in the Middle Ages was the periodical fair, which was supervised by Church institutions. Italian merchant cities had also well organised local markets. In the Most Serene Republic of Venice, for instance, there were specialised markets to respond to the special trading needs of different merchant groups. Derivatives mainly remained, in the current terminology, “over-the-counter” but the markets offered a kind of organisation with regard to the “counters”. Over time, periodical medieval markets lost their importance in trade in favour of permanent trading places located at the junction of port sites and land routes.
From the 1970s on, the USA has been the cradle of innovation in derivatives. The development of computers and their growing use in finance, which allowed complex models and computations to be quickly solved, but also the lenient regulatory regime constituted key elements for innovation. Financial innovations were first introduced by exchanges. For instance, the Chicago Mercantile Exchange launched futures contracts written on financial instruments in 1972 or the Chicago Board of Trade introduced the first interest rate futures contracts in 1975.
Financial innovations in OTC derivatives occurred in the early 1980s. In the second half of the eighties, the first collateralised debt obligations were issued by a Wall Street investment bank. However, derivatives trading still mainly took place on exchanges, but not for long. Already in 1991, the notional amount of OTC derivatives trading surpassed exchanged-traded derivatives. The nineties saw, among other things, the emergence of modern credit default swaps and then about a decade later… came the subprime crisis which will undoubtedly leave a permanent trace in the history of derivatives
