A move intended to create more transparency in the market for credit default swaps kicked off this week, but so far the change is unnoticeable to buyers, says a trader of the derivatives.
IntercontinentalExchange on Monday began clearing CDS trades, after becoming the first entity to win the right to do so from the Securities and Exchange Commission in October. CME Group received approval on March 13 to clear the derivatives. CME spokesperson Allen Schoenberg said as soon as they come to terms with customers they can put them on the platform and begin trading.
One trader active on the buy side says that dealers prefer the IntercontinentalExchange model over the CME’s proposed system. IntercontinentalExchange, as part of its SEC application, purchased The Clearing Corp., which was run by 11 financial institutions that were heavily involved in the market and was the insider’s original mechanism for clearing CDS. The trader, who did not want to be named, also suggested that dealers like IntercontinentalExchange because the clients will have less visibility through its format than they would through the CME, once again giving the dealers a certain amount of desired opaqueness. But he concedes that the new rules will be tougher on the banks and better for the buy side.
"The banks had too much control," the trader said. "They could, on a whim, make it more or less attractive to buy more protection on a company by changing the amounts they charged for trading the CDS." The trader said the real change will be on April 8, when the move to standardize contracts takes place. He said that with standardization it will be easier to fully net his books out and keep things more balanced.
"Currently the contracts for the CDS are all over the place," the trader says. "You have 100-basis point coupons, 500-basis point coupons. The effective dates are all different."
CDS are insurance against default of debt, which can be bought, sold and traded by anyone. They traditionally have been traded in unregulated, over-the-counter markets, but their role in the economic meltdown has led to a push on Capitol Hill and elsewhere for more regulation.
| CREDIT DEFAULT SWAP |
A credit default swap (CDS) is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults. CDS contracts have been compared with insurance, because the buyer pays a premium and, in return, receives a sum of money if one of the specified events occur. However, there are a number of differences between CDS and insurance, for example:
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After what we’ve been through [and are still going through], just the mention of Credit Default Swaps should make us all shudder. There’s a feud brewing even with all the horror of the sub-prime/housing-bubble/AIG/CDS debacle. In spite of the danger of these "complex instruments," the financial industry is in love with the idea of insuring risk. So getting rid of these horrible things is unlikely. So things have to change.
1. above has to go. It’s absurd to have something like this financial instrument that’s capable of tanking the global economy traded by unregistered people. 2. and 3. are about using these CDS’s as collateral for a variety of leveraging techniques. That is a complex area that needs careful scrutiny, as it’s part of how the current crisis developed – putting up insurance as collateral. 4. is absolutely nuts – bucket shop, Las Vegas stuff. Buying insurance on something you don’t own is ridiculous.
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