Markit Launches CDS Data Portal

Markit, a financial information services company, today announced the launch of a credit default swap information portal designed to increase transparency and provide a broader audience with a tool to monitor the market.

The new data portal will make a wide range of Markit's independent CDS data sets publicly available, including: prices for Markit's family of CDS indices, the Markit CDX and Markit iTraxx; the last quote received by Markit before New York close of trading for approximately 450 of the most liquid CDS contracts, including G20 sovereigns, large financial corporations and constituents of Markit's iTraxx and CDX indices; the biggest daily single name CDS movers for North America, Europe and Asia; and daily Markit/ICE TrustTM CDS settlement prices for the most liquid Markit CDX index contracts listed for clearing by ICE Trust.

In support of the industry's migration to a standardized CDS contract and quoting convention, Markit has published a free online calculator that converts CDS spreads into the new upfront quoting convention. Markit will also publish educational material to encourage greater understanding of the CDS market.

"The CDS market is viewed as the barometer of health for the broad credit markets," said Armins Rusis, global co-head of fixed income at Markit. "It is therefore important to make information about this market as widely available as possible. Markit remains committed to increasing transparency in the CDS market and we will continue to work with the industry to help it adapt to a changing environment."

Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=216000013

Despite Misconceptions, Credit Default Swap Market is Growing

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

Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=215800447

When Counterparties Fail (Waters Special Report)

The demise of Bear Stearns and Lehman Brothers has thrown the default threat onto center stage. Credit risk is guiding trading strategies like never before as technologists scramble to provide the front office with real counterparty risk measurement. By Joe Morgan

When Bear Stearns collapsed in the spring of last year it completely changed the thinking of risk managers across the globe. Gone were the days when capital markets firms could simply focus their attention upon the risks of financial products blowing up. Buy- and sell-side firms now had to ask the question: Will the firm we are doing business with still be around tomorrow?

Anyone misguided enough to believe that it could still be "business as usual" in the capital markets after the demise of Bear Stearns had their illusions shattered when Lehman Brothers filed for Chapter 11 bankruptcy protection last September.

"Counterparty credit risk came to the forefront after Bear Stearns. The fact that even a major global bank could disappear scared everyone," says Kevin McPartland, a senior analyst at consultancy firm Tabb Group in New York. The collapse of giants in the financial world has completely changed capital markets firms' attitude toward counterparty credit risk. It would have previously been unthinkable that a credit default swap (CDS) purchased from a bulge-bracket firm would become worthless in the wake of the bank failing. Now risk managers have to consider the dual threats of both the underlying financial risk that a CDS is taken out to protect against, and the risk of the bank arranging the trade collapsing. This has increased the overlap between risk management and trading like never before.

Market analysts point out that capital markets firms are increasingly providing traders with the facility to check with the firm's credit risk models before executing trades. Those without automated processes in place to link a credit department's risk data with its trading desks are requiring traders to pick up the phone more often and speak with risk managers, particularly before executing major transactions.

Chicago-based complex event processing (CEP) technology vendor Aleri claims it has experienced a recent upsurge in demand-particularly among sell-side firms-for its suite of solutions. CEP technology consolidates trades, market prices, and settlement reports, enabling a firm to obtain an updated view of risk exposure in real time. In addition, a firm can impose pre-trade limits and caps on the exposure dealers can take with a particular counterparty.

"The bottom line is that many firms that have collected information in the past have not done so in a timely enough fashion," says Jeff Wootton, vice president at Aleri in Chicago. He says the CEP system takes native data from different risk and trading systems within a firm and aggregates it along different dimensions in real time. "From the consolidated view, you can then drill down all the way to the individual transaction level, managing trading positions and exposure in a certain asset class, location or with a particular counterparty."

Buy-side and sell-side firms have also been forced to replace risk models in the wake of the financial crisis. PJ Di Giammarino, CEO of JWG-IT Group, a financial services think tank based in London, describes the counterparty risk management framework used by capital markets firms a year ago as "fundamentally flawed." He says there is now a need for more timely and granular customer information on demand. "However, this higher quality data needs to be distributed across the firm without slowing down its trading desk. Reducing latency of changes in the customers' state is critical. Time is a luxury firms do not have," he says.

Bob Giffords, an independent banking and technology analyst based in the UK, says risk models now have to be redesigned and recalibrated for new correlation risks and to fit them into "the rapidly diminishing interstices between trades." He expects this to require more hardware along with a closer scrutiny of the links between financial products, especially via liquidity, contagious market sentiment, or external political events. "Multi-model strategies may well start to emerge as we've seen for investment," says Giffords. Different models show different risk factors and are then weighted based on market or even political conditions. "When the market is jittery and trading is thin, sentiment models may dominate, while during more confident, liquid periods we would expect to see models based on fundamentals to increase their weighting," he says.

Rohan Douglas, CEO of Quantifi, a financial software vendor in London, says the current financial crisis has resulted in regional banks and many large buy-side participants adopting a sophisticated approach to counterparty credit risk that was previously the almost exclusive purview of bulge-bracket firms such as Goldman Sachs. Risk modeling techniques used to price financial instruments are being used to measure the counterparty risk on individual trades. However, Douglas says that firms scrambling to implement more stringent counterparty credit checks now in the wake of the current market turmoil are still in danger. "The main thing that will come out of this the financial crisis is that you really need these tools and infrastructure in place before a crisis takes place," he says.

More CPR Power

Douglas says he believes that credit and counterparty risk will continue to loom larger in the minds of buy-side and sell-side firms, regardless of the current market turmoil. "The longer term trend will be that credit and the measuring of counterparty risks will be increasingly important," he says.

Buy-side and sell-side firms' increasing focus on measuring counterparty credit risk will provide technologists with significant challenges. Capital markets firms will have to gather more information on levels of risk exposure to counterparties and process it in a shorter amount of time while also distributing the information between credit risk and trading departments. "High-performance computing (HPC) technology is being used to crunch numbers faster. Whereas before a firm's risk exposure would be calculated overnight it is now being done in just one hour," says McPartland.

Capital markets firms are taking a two-fold approach to enhancing the computational power that can be used to power risk management systems: complex calculations are being spread out across multiple processors, while firms are also undertaking initiatives to more efficiently utilize their computing resources. Grid technology-which is already being increasingly utilized by capital markets firms absorbing cutbacks in IT spending-is being used to fulfill more risk management tasks. Instead of running models through Microsoft Excel spreadsheets on local desktops the number crunching is now being done in a grid environment. Server blades in datacenters are also increasingly being shared. McPartland of the Tabb Group says the "cloud computing idea"-where employees book a certain amount of processors for an agreed length of time-is gaining traction among capital markets firms. "This way you get access to what you need to do, such as carry out a report, before the computational resources go back into the pool," he says. "The old way of doing things would be for a couple of servers to be used for two hours and then left idle for the rest of the day." (For more on cloud computing, please turn to page 46.)

Buy-side and sell-side firms specializing in high-speed, high-frequency trading strategies are increasingly incorporating graphics processing unit (GPU) technology to reduce latency. GPUs were originally developed by Santa Clara, Calif.-based Nvidia to support 3D graphics in the computer gaming industry in 1999. The visual computing technology vendor has since launched its Tesla product to provide capital markets firms with high-performance computing solutions that can reduce the latency of risk management applications. "The use of GPUs is still cutting-edge," says McPartland. "The firms that utilize this type of technology do not like to talk about it as they are often quite secretive about their trading strategies." Bulge-bracket sell-side firms, proprietary trading firms and hedge funds are among those believed to be adopting GPU technology in their counterparty credit risk systems.

The use of GPUs can speed up number-crunching tasks such as performing Monte Carlo simulations for the pricing of derivatives. The technology is being used for data storage. For example, in an options contract, multiple data needs to be stored, including its strike price, whether it is a "call" or a "put" and the underlying security the option is linked to. "Different firms store data on options in different ways. GPUs can be used to quickly turn the data into a consistent format in real time, enabling the information to be more easily analyzed," says McPartland. The technology is also being used to enhance and normalize streaming market data before it is transferred to risk models and algorithmic trading engines. The capacity to process data into a consistent format before being incorporated into a front-end trading system is becoming increasingly vital in the risk management processes of buy-side and sell-side firms, which increasingly rely upon different types of data from multiple exchanges and trading platforms.

CDSes GO ELECTRONIC

In October last year the Chicago Mercantile Exchange (CME) and Chicago-based alternative investment firm Citadel Investment Group unveiled plans to set up an independent electronic trading platform for trading CDSes. The platform will function as an electronic exchange for CDS trading, with CME Clearing acting as a central counterparty to guarantee trades. Major CDS market participants have been invited to join the platform as founding members by allocating up to 30 percent of the equity in the venture and committing to becoming market-makers when the platform is launched later this year.

Across the pond, the European Commission is spearheading drives for a centralized clearing model for derivatives instruments such as CDSes. Three exchanges are vying for this business: NYSELiffe, in conjunction with London-based LCH.Clearnet; Frankfurt-based Deutsche Börse's Eurex Clearing; and Atlanta-based IntercontinentalExchange (ICE), which is in talks with UK regulators about allowing its London-based ICE Clear Europe to clear CDSes. Nine of the major dealer firms in the CDS markets have committed to the use of central counterparty clearing for CDSes in Europe by July this year. In a letter sent to EU Commissioner Charlie McCreevy in February, the nine banks-Barclays Capital, Citigroup Global Markets, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley and UBS-agreed to work closely with infrastructure providers, regulators and the European Commission to resolve technical, regulatory, legal and practical hurdles. Each firm will make its own choice on which central clearinghouse or houses might best meet its risk management criteria.

A source who works for a trading technology vendor that is providing technology from its core credit risk platform to some of the parties involved in the current bidding war to become a central counterparty for CDSes says market participants are "waking up to the fact that counterparty credit risk is real." The source-who reports a recent increase in demand from insurance companies for credit risk solutions-says: "There will be increasing moves toward a centrally cleared infrastructure for liquid products in the capital markets while more bespoke instruments continue to be traded on a bilateral basis."

The demand among market participants for a centrally cleared model for the trading of credit products is likely to increase as volatile financial markets remain unstable and in uncharted territory, with traditional providers of liquidity such as hedge funds retreating from the market place. These conditions will also result in greater investment in risk management technology as firms try to navigate-and survive-the current market conditions. Developing risk and trading models that provide appropriate levels of protection against the risk of default-while also enabling the firms to profit from the turbulent market terrain-will be vital.

Observers note that this will make latency increasingly important as capital markets firms monitor their trading positions in real time. Few risk managers will be willing to wait until the next day before checking up on exposure to any counterparty, no matter how big the name. After all, no investment firm wants to be the next Lehman Brothers.

 

Source URL: http://www.watersonline.com/public/showPage.html?page=printer_friendly&print=845244

Cooperation Announced Between Global CDS CCP Regulators

Representatives from regulatory agencies with direct authority over one or more of the existing or proposed credit-default swap central counterparties (CDS CCP) discussed today possible information sharing arrangements and other methods of cooperation within the regulatory community.

Today’s discussion follows an initial meeting held at the Federal Reserve Bank of New York on January 12, 2009. The discussions included representatives from the Federal Reserve, Commodity Futures Trading Commission, U.K. Financial Services Authority, the German Federal Financial Services Authority (BaFin), Deutsche Bundesbank, the New York State Banking Department, the Securities and Exchange Commission, and the European Central Bank and the Hungarian Financial Services Authority in their roles as co-chairs of the joint ESCB-CESR Working Group on Central Counterparties.

The primary objectives of the effort discussed today include:

• Mutually supporting each regulator in carrying out its respective authorities and responsibilities with respect to CDS CCPs; and

• Applying consistent standards and promoting consistent public policy objectives and oversight approaches for all CDS CCPs.

To facilitate communication among the regulatory community with respect to all CDS CCPs, CDS CCP regulators plan to host a workshop in the near future with representatives of other interested regulators and governmental authorities that are currently considering CDS market matters, to discuss the CDS CCP regulatory interests and information needs of other authorities and the market more broadly.

Source URL: http://www.anotherfp.com/newsite/story.php?id=889

CDS dealers bow to pressure and commit to EU clearing counterparty

Nine of the leading dealer firms in the credit default swaps markets have committed to the use of central counterparty clearing for CDS in the European Union by end-July 2009.

In a letter to EU Commissioner Charlie McCreevy, the nine dealers - Barclays Capital, Citigroup Global Markets, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley and UBS - have agreed to work closely with infrastructure providers, regulators and the European Commission in resolving outstanding technical, regulatory, legal and practical issues. Each firm will make an individual choice on which central clearing house or houses might best meet its risk management objectives, subject to regulatory approval of any such clearing house in Europe.

The move follows the threat of legislative action by the European Commission after the industry failed to meet an end-December deadline to deliver a detailed plan for CDS clearing in the eurozone.

Last week, London-based LCH.Clearnet announced plans to launch a clearing service for credit default swaps in the Eurozone by December 2009.

The initiative has sparked a flurry of activity in France, where the central bank has called on eurozone countries to come up with an alternative solution to counter the challenge posed by the creation of systemically-significant clearing bodies in London and the US.

In a document seen by the FT, the Banque de France called for the creation of a "consortium of eurozone banks and shareholders of major infrastructures with the objective of developing a common strategy for the integration of several of the eurozone's prinicple clearing houses".

Separately, IntercontinentalExchange, which is looking to set up a global clearing house from the US, has announced plans to set up a European equivalent, dubbed ICE Trust Europe and set a H1 2009 launch date.

 

Source URL: http://www.finextra.com/fullstory.asp?id=19659

JPMorgan sacrifices CDS engine to open source in bid to stave off legislation

JPMorgan is to hand over its inhouse-developed CDS analytical engine to the International Swaps and Derivatives Association to run as an open platform in an effort to increase transparency in credit default swaps pricing and stave off legislation.

The CDS analytical engine, originally developed by the Quantitative Research group at JPMorgan, is widely used in the industry to price CDS contracts.

Isda says it will make the technology available as open source code, thereby increasing transparency around CDS pricing.

Robert Pickel, executive director and chief executive officer, Isda, describes the initiative as another measure of the industry's efforts to raise transparency and increase standardisation in CDS trading.

"JPMorgan has invested a lot of intellectual capital in this analytical engine," he says. "Its willingness to assign this to Isda for us to make it available as open source to the entire industry demonstrates our collective commitment to the integrity of the CDS product."

The move comes as Isda fights a draft US bill proposed by congressman Collin Peterson that would ban most forms of CDS trading.

"This bill would increase the cost and reduce the availability of essential risk management tools while failing to address the true causes of the credit crisis," says Eraj Shirvani, Isda chairman and head of European and Pacific credit sales and trading at Credit Suisse.

 

Source URL: http://www.finextra.com/fullstory.asp?id=19587

Cheque mate - How AIG got Uncle Sam over a barrel

JUST how concerned should American taxpayers be about American International Group (AIG), the insurance company brought to its knees by its escapades in the credit-derivatives market? On November 10th a revised rescue package was announced, comprising $153 billion of capital injections and loans. That is the largest bail-out for any firm, anywhere, during the crisis. Is the government being, as AIG’s new chairman says, “very, very smart”, or has it been taken for one of the most expensive rides in corporate history?

Even on September 16th, when the state first intervened, AIG was a controversial candidate for assistance. Its insurance businesses are ring-fenced by local regulators and individually capitalised, precisely so they can survive a collapse of the holding company. A bankruptcy was avoided only because of the size of the holding company’s book of toxic credit derivatives, which senior executives barely understood. These left AIG so intertwined with other financial firms that its failure was judged by the Federal Reserve and Treasury to endanger the financial system.

Whether that judgment was right remains unknowable. But it is now clear that the original plan was flawed. That may be understandable: panic was in the air, AIG faced crippling collateral calls and Lehman Brothers had just folded. And the authorities lacked the wide powers granted by the Troubled Asset Relief Programme (TARP) approved by Congress in October. Unorthodox options, such as splitting the systemically threatening credit derivatives from AIG, were not under discussion.

As a result, the original plan looked a lot like the traditional remedy for a liquidity crisis at a solvent bank. The Fed offered a two-year, $85 billion loan. AIG would pay a penal interest rate and cede to the state an equity stake of just under 80%. But as collateral calls mounted on the credit derivatives, and AIG admitted to new problems, it became plain that the loan was too small. It was also too expensive: in the first year it would have cost almost as much as AIG’s profits in 2006, its best year ever.

Meanwhile the chances of AIG being able to repay the loan also shrank. In the second quarter, it had only $59 billion of core equity capital (defined here as book equity less goodwill, tax assets and stock ceded to the state). By the third quarter, more losses had cut this to a meagre $23 billion. Worse, much if not all of AIG’s capital sits “stranded” in the ring-fenced insurance units. That makes it hard to funnel it up to a holding company that is otherwise almost certainly insolvent.

The original solution was to sell the insurance operations to raise cash, but with AIG’s competitors also reeling, this looked less and less realistic. The alternative, of AIG tapping credit markets to repay the state, became ridiculous by early November. AIG’s own credit spreads implied that the company was headed for default (see chart). Prospects of even rolling over the $64 billion of non-government borrowing due to mature by 2011 became increasingly bleak.

That forced the hand of the authorities. In one sense the new package does what, with the benefit of hindsight, should have happened all along. The Fed will provide $53 billion of funding for two vehicles which will, in effect, assume AIG’s most toxic credit derivatives and mortgage-backed securities. These positions have been marked to fairly conservative levels.

In an alternative universe the government could then walk away, confident that it had dealt with the worst of the systemically important credit derivatives and that the insurance operations remained safely ring-fenced. But in the real world the state is now the biggest lender to AIG, which has drawn down the bulk of the original $85 billion facility. AIG has Uncle Sam in a bind. As a result, the Treasury, through the TARP, has been forced to recapitalise the insurer by purchasing $40 billion of preference shares. Despite this its economic stake in the firm will remain just below 80%. The Fed will also maintain a loan facility, on more generous terms, of $60 billion. And if AIG struggles to refinance its debts, it is quite possible that the state will provide a formal guarantee.

The Treasury has secured crowd-pleasing concessions; for example limits on executives’ bonus payments. But the real question is whether the preference shares are safe. AIG has a trillion-dollar balance-sheet. There is now a thin buffer of core equity between the taxpayer’s preference shares and any further losses. The hope is still that as markets recover, AIG can sell the crown jewels of its insurance business at a premium to book value. That may well take years. Plenty of time to reflect on how an offer of a temporary loan, to a company that barely made the list of systemically vital firms, spiralled into one of the biggest corporate bail-outs ever.

Source URL: http://www.economist.com/finance/displaystory.cfm?story_id=12607251&fsrc=rss

Auction Settles $400 Billion Worth of Lehman-Related CDSs

In an auction held today for the bankrupt Lehman Brothers by the International Swaps and Derivatives Association, Markit and Creditex, $400 billion worth of Lehman-referencing credit default swaps were settled. The final price for the contracts was 8.625%, in other words, sellers of credit-default protection will have to pay holders 91.375 cents on the dollar. (The total amount of cash exchanged will net out to about 2% of that $400 billion notional amount because the participating firms have multiple contracts with each other.) The auction took place electronically on a Creditex trading platform.

At a press conference this afternoon, ISDA executive director and chief executive officer Robert Pickel spoke proudly of the event, saying the auction went smoothly and efficiently, following successful implementation of ISDA's CDS protocol. He noted that auctions for Fannie Mae and Freddie Mac related derivatives took place earlier this week and that upcoming auctions will settle derivatives referencing Washginton Mutual and three Iceland banks.

Pickel spoke glowingly of the CDS market in general. "Despite defaults in recent months, CDS markets remain strong," he said. "CDSs have come under scrutiny and criticism lately, but CDS contracts did not cause any firm to fail. The underlying problem affecting firms is the risks they chose to take on."

Publish Date: October 10, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=211100202

The Rush to Regulate Credit Default Swaps

It seems like politicians, regulators and even the average Joe on the street now knows something about credit derivatives. These complex instruments are being blamed for the near meltdown in the financial system. No one outside of the credit markets paid much attention to credit default swaps or CDS until they threatened Bear Stearns and Lehman Brothers.

On Monday, New York State Governor David Patterson said his state had the authority to regulate part of the credit default swap market and would require issuers to register as insurance dealers. Patterson told the media that his state’s insurance department would regulate CDS as insurance products in cases where the buyer of the derivative owns the underlying bond.
But the chorus of voices recommending increased regulation of credit default swaps has been growing in recent days, following the bankruptcy of Lehman Brothers, the fall of Fannie Mae and Freddie Mac and the bailout of AIG.

On Tuesday, SEC Chairman Christopher Cox called for giving the agency the authority to regulate credit default swaps. Testifying before the Senate Banking Committee on the turmoil in U.S. credit markets, Cox told Congress “the $58 trillion notional market in credit default swaps— double the amount outstanding in 2006 – is regulated by no one.”

Right now these over-the counterderivatives are not traded on an exchange, and are not regulated by any of the traditional regulators- such as the SEC or CFTC. “Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market,” Cox told the Senate.

It’s believed that the credit derivatives market contributed to the fall of Lehman Brothers and AIG, as the cost to buy protection against a bond default surged and pushed down their stock prices.

But the real danger is that brokers and hedge funds were apparently using credit default swaps to speculate on which financial trading counterparty would default next. They could sell the CDS without owning the underlying bond on which it was based. “Economically, a CDS buyer is tantamount to a short seller of the bond underlying the CDS,” said Cox in his speech. “This means CDS buyers can ‘naked short’ the debt of companies without restriction.”

Some traders used the credit default swaps to bet on the likelihood of default in the bonds of their trading counterparties, namely Lehman Brothers, AIG and Morgan Stanley. As the cost of buying protection against holding the bonds of banks and brokers surged, traders used that as a signal to short the stocks, which caused the credit agencies to lower their ratings, thereby raising the cost of capital for these companies and sending them into a cash crunch and death spiral. The SEC is concerned that credit derivatives were used to manipulate the pries of securities companies and drive them out of business.

As part of its stepped up enforcement efforts, Cox told Congress, the SEC is conducting a sweeping investigation of market manipulation of financial institutions, focused on broker-dealers and institutional investors with significant trading activity in financial issuers and with positions in credit defaults swaps. It would be easier to conduct the investigation if these instruments were traded electronically on a centralized exchange. But CDSs are for the most part traded over-the-counter, between dealers, banks and asset managers. On the dealer side, Creditex, a business that was owned by the dealers and recently sold to the InterContinental Exchange (ICE) offers an execution platform for use by the dealers.

It’s clear that regulators are now focusing on the need for oversight and transparency in credit derivatives. Usage of CDS has grown dramatically among traditional asset managers and hedge funds, which means they are exposed to the counterparty risk of the investment banks that sold them protection. No doubt, there will be renewed calls for trading credit derivatives on exchanges, which can work for standardized, highly liquid contracts, and for a central clearing counterparty. But what will happen to the more customized instruments, known as bespoke instruments? In a research note published this week, TowerGroup’s Senior Research Director for Investment Management, Dushyant Shahrawat, predicts, “Brokerage firms burned by OTC derivatives like credit default swaps and other esoteric structured products will greatly reduce their involvement in these instruments.” Despite resistance from the dealers, Bloomberg reported yesterday that credit swaps could move to an exchange in order to exist.

In the meantime, politicians are learning more about these instruments and forming quick opinions. Patterson told The New York Times he had not heard of credit default swaps until he read an article in The Economist six months ago. He said he thought they should be regulated by the gaming industry and he equated the derivatives with gambling.

Publish Date: September 25, 2008
Source URL: http://www.advancedtrading.com/blog/archives/2008/09/the_rush_to_reg.html?cid=nl_wallstreettech_daily

TABB Group Forecasts Monthly Novation of Credit Default Swap (CDS)

Eighteen years after the credit default swap (CDS) was created to help firms hedge against the risk of default of a given asset, TABB Group estimates that the average notional value at risk (the total value of a leveraged position's assets) of trades novated monthly will exceed $45.2 trillion by 2010, an 88% CAGR (compound average growth rate) from 2005.

Kevin McPartland, senior analyst and author of the new TABB Group research report "Credit Default Swaps: The Risk of Inefficient Markets," said in a press release that 90% of all CDS trades are confirmed electronically, but same-day matching of new trades and novations is rare and error rates are unacceptably high. "This is a lot of money to risk on a phone call," he added. TABB Group forecasts that nearly $170 million will be spent in 2010 by major sell-side broker-dealers to automate the affirmation process and mitigate the potential risk resulting from trade exceptions.

Despite current available technology, details of most CDS trades are still not affirmed between counterparties on trade date. The delay is not in legally confirming or settling trades, but simply in agreeing that each party recorded the same basic trade details such as the reference entity or notional amount. Where overnight batch jobs were once accepted solutions, with 2008 trading volumes and market volatility levels, explains McPartland in the release, "the risk created by not understanding your market and counterparty exposure until the next morning makes this standard practice rather unacceptable."

Publish Date: Sepember 04, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=210300535