Monday, January 10, 2011

CDS compression amounts have fallen (TriOptima Press Release)

TriOptima announced that its triReduce portfolio compression service had eliminated $45.8 trillion in interest rate swap notionals in a record 53 cycles and $8.5 trillion in credit default swap notionals in a record 95 compression cycles during 2010.

Terminations in interest rate swaps increased significantly in 2010 with 53 triReduce Rates cycles in 23 currencies around the globe eliminating $45.8 trillion in notional outstanding, up from $26.7 trillion in 2009. This included nine cycles run in conjunction with LCH.Clearnet Swapclear. “2010 was another successful year in triReduce rates,” said Raf Pritchard, CEO of TriOptima North America. “We expanded the range of interest rate swap currencies we cover to Israeli Shekel (ILS) and Thai Baht (THB). Terminations in currencies like these with higher capital requirements can free up capital for redeployment and reduce counterparty credit risk. Furthermore, with strong cycles in JPY and eight other Asian currencies, our activities in Asia continue to gain traction.”

Compression results in credit default swaps have decreased since their peak in 2008 when triReduce Credit cycles eliminated $30.2 trillion in notional outstanding. “The success of our compression efforts in previous years as well as the increased industry efforts and prioritization accorded to clearing contributed to lower compression levels for CDS index trades in 2010,” said Raf Pritchard. “However, we have seen a doubling in the termination of single name trades since 2008 due to the introduction of coupon standardization in ISDA’s Small Bang.”

Since the introduction of its innovative triReduce service in 2003, TriOptima has terminated $108 trillion in IRS notional outstandings and $68.2 trillion in CDS notional outstandings. Full compression statistics are available on TriOptima’s website at:

Sunday, December 12, 2010

Counterparty risk and contract volumes in the credit default swap market (BIS)

by Nicholas Vause

Abstract: After more than a decade of rapid growth, the volume of outstanding credit default swaps peaked at almost $60 trillion at the end of 2007. Since then it has nearly halved, while turnover has continued to rise. The decline in volumes outstanding reflects intensified efforts to reduce counterparty risk, which have eliminated more than $65 trillion of offsetting positions.

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Tuesday, December 7, 2010

The Inefficiency of Clearing Mandates (Craig Pirrong)

Abstract: In the aftermath of the financial crisis, attention has turned to reducing systemic risk in the derivatives markets. Much of this attention has focused on counterparty risk in the over-the-counter market, where trades are bilaterally executed between dealers and derivative purchasers. One proposal for addressing such counterparty risk is to mandate the trading of derivatives over a centralized clearinghouse. This paper lays out the advantages and risks to a mandated clearing requirement, showing how, in some instances, such a mandate can actually increase systemic risk and result in more financial bailouts.

This paper also describes the dynamics of counterparty risk in the derivatives market. Discussing the relative importance of both the risk that arises from the price risk of the instrument at issue and the financial condition of the counterparty. The analysis then turns to an evaluation of how bilateral markets and clearinghouses manage these two risks. After demonstrating that resolving and replacing defaulted trades is the primary resolution problem facing both market structures, the paper lays out an auction alternative designed to address this issue.

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Thursday, December 2, 2010

An Analysis of Euro Area Sovereign CDS and their Relation with Government Bonds

by Alessandro Fontana, and Martin Scheicher
ECB Working Paper No. 1271

Abstract: This paper studies the relative pricing of euro area sovereign CDS and the underlying government bonds. Our sample comprises weekly CDS and bond spreads of ten euro area countries for the period from January 2006 to June 2010. We first compare the determinants of CDS spreads and bond spreads and test how the crisis has affected market pricing. Then we analyse the ‘basis’ between CDS spreads and bond spreads and which factors drive pricing differences between the two markets. Our first main finding is that the recent repricing of sovereign credit risk in the CDS market seems mostly due to common factors. Second, since September 2008, CDS spreads have on average exceeded bond spreads, which may have been due to ‘flight to liquidity’ effects and limits to arbitrage. Third, since September 2008, market integration for bonds and CDS varies across countries: In half of the sample countries, price discovery takes place in the CDS market and in the other half, price discovery is observed in the bond market.

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The impact of CDS trading on the bond market: evidence from Asia

by Ilhyock Shim and Haibin Zhu
BIS Working Papers No 332

Abstract: This paper investigates the impact of CDS trading on the development of the bond market in Asia. In general, CDS trading has lowered the cost of issuing bonds and enhanced the liquidity in the bond market. The positive impact is stronger for smaller firms, non-financial firms and those firms with higher liquidity in the CDS market. These empirical findings support the diversification and information hypotheses in the literature. Nevertheless, CDS trading has also introduced a new source of risk. There is strong evidence that, at the peak of the recent global financial crisis, those firms included in CDS indices faced higher bond yield spreads than those not included.

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Tuesday, November 23, 2010

What Reforms for the Credit Rating Industry? A European Perspective (SSRN)

By Karel Lannoo (Centre for European Policy Studies, Brussels)

Abstract: Despite having singled out credit rating agencies (CRAs) early on in the financial crisis as needing more regulation, policy-makers in the EU seem not to be reassured by the measures that have been adopted in the meantime, and want to go further. This paper starts with an overview of the credit rating industry today. The second section analyses the use of credit ratings and shows how the authorities have created a captive or artificial market for CRAs. Section 3 reviews the new EU CRA regulation and its possible impact, and the final section compares proposals for regulatory reform.

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Monday, November 22, 2010

The Effect of Market Structure on Counterparty Risk (SSRN)

By Dale W. R. Rosenthal

Abstract: Two network structures of derivative contracts are studied as representatives of a bilaterally-cleared OTC market and a centrally-cleared market. An initial bankruptcy induces counterparties to trade with price impact. The two market structures yield economically different price impact, volatility and follow-on bankruptcies. A large market-induced bankruptcy yields two destabilizing phenomena in bilateral markets: checkmate and hunting. Checkmate occurs when a counterparty cannot expect to prevent impending bankruptcy. Hunting occurs when counterparties push markets further than necessary, inducing further bankruptcies which may yield profits. The results suggest that bilateral OTC markets have larger externalities (distress volatility) which can be priced relative to centrally-cleared markets. Bilateral OTC markets are also more sub ject to liquidity and funding crises. This has real effects: follow-on bankruptcies, unemployment, a reduction in tax revenue, higher transactions costs, less risk sharing, and thus a reduction in allocative efficiency. Pricing the distress volatility may suggest when and how to encourage markets to transition from bilateral OTC to central clearing. The results also suggest that limiting leverage ratios may reduce distress, that leverage limits may not vary linearly with capital, and that in times of distress coordination by market authorities has value.

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Friday, November 19, 2010

Australian and Japanese Authorities Seek Permanent SEC Rule 17g-5 Exemption

The Australian Securitisation Forum ("AuSF") and Japanese Financial Services Agency (FSA) have submitted letters to the SEC staff in which they have requested that the Commission make permanent the exemption for extraterritorial ratings from requirements of Rule 17g-5. Please click here for the AuSF letter and here for the FSA counterpart.