Monday, 2 February 2009

Overhaul on Credit Default Swaps Market May Be Announced by March. What Are the Real Implications?

Investors have agreed to a series of measures aimed at overhauling the market for credit-default swaps to curb risks and make it easier to settle problematic situations. The solutions might be presented in March, according to several newswires that reported the event on Friday. Under the proposals, CDS may look and be designed more like bonds; an oversight committee might be created to arbitrate disputes.

You, dear reader, probably know that trading on the international derivatives exchanges retreated in the third quarter. Total turnover based on notional amounts decreased to $542 trillion from $600 trillion in the second quarter, according to the Bank for International Settlements (BIS.) While most of the contraction took place in derivatives on short-term interest rates. In the global OTC derivatives markets, CDS contracts registered their first ever decline (a drop of 1 percent) in the first half, compared with an average six-month growth rate for outstanding CDS contracts of 45 percent over the past three years, said the BIS. The fall was due largely to a significantly higher number of multilateral terminations of CDS contracts, as a result of the financial turbulence.

The changes are key to increase transparency in an industry where opacity is the rule, not the exception (remember the case if Ecuador and the default. We still have no idea why some contracts weren't called off.) Another goal of this overhaul plan would be to mitigate the risk of systemic failures and ease the way disputes are worked out.

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