Pre-dating Wall Street's current financial crisis, the credit default swaps market generated heated debate and discussion, moving from an initial focus on confirmation backlogs to a central counterparty clearing model and more recently to the possibility of requiring these products to trade on an exchange. Unfortunately, misconceptions regarding the utility and purpose of credit default swaps continue to spread and the financial industry's efforts to defend these instruments have been met with disdain by legislators seeking oversight of the CDS industry through misguided regulatory efforts.
But according to Kevin McPartland, senior analyst at Tabb Group and author of the new research report, "Credit Default Swaps: Industry Projections," although the outstanding notional value of the CDS market has declined dramatically largely due to trade compression, CDS market revenues from central clearing, electronic trading and existing trade migration will grow to $174 million, growing at 12% CAGR (compound annual growth rate) through 2011.
A new regulatory structure including central clearing and increased electronic trading, says McPartland, will streamline the market, lower barriers to entry for buy-side firms and ultimately increase volumes. "However, beyond the ubiquitous counterparty risk issue, concerns over operational efficiency issues continue to plague the CDS market at the same time that global regulators are pushing the industry to adopt central clearing for CDS trades and increase market transparency."
He explains how four proposed major initiatives from CME/Citadel, NYSE Euronext, Eurex and ICE (which includes Creditex and TCC), each vying to be the central counterparty of choice for the CDS market, will allow trades into their clearing houses from nearly any execution platform, including those operated by their competition. He does caution, however, that even when the first central clearing entity come online, a number of challenges will remain that require further thought and innovation.
Despite strong backing by regulators, he says that there are some in the industry who believe the problems with a central clearing solution for the CDS markets go deeper. "At least one alternative approach, NetDelta, a wholly-owned subsidiary of Knight Trading, currently exists, and others are likely in the works."
Casting an eye to the future, he also identifies three issues worth tracking: CDS market transparency; mandates; and electronic trading
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