Counterparty Risk in Nonstandardized Credit Default Swaps Market

by Anshuman Jaswal, PhD, November 24, 2009
Product Trends/ Reviews
Global, Asia-Pacific, EMEA, Latin America, North America

Abstract

A study by Celent looks at the credit default swaps (CDS) market and analyzes recent issues.

In this report, Counterparty Risk in Nonstandardized Credit Default Swaps Market, Celent looks at the state of the CDS market and discusses the various measures that have been taken to reduce risk since the credit crunch. It also evaluates a number of recommendations to reduce counterparty risk at the systemic level.

Single-name CDS volume, as a share of notional outstanding volume, has gone up since the second half of 2007 and even exceeded 2006 levels in 2009. This underlines the important role of nonstandardized CDS in the credit derivatives market and highlights the need to deal with counterparty risk for this category.

“The leading banks/dealers in the OTC derivatives markets are the main buyers and sellers of CDS. Hence, the chances of having them as a counterparty are quite high. This circularity within the system increases counterparty risk and we need to tackle it without hampering the market performance,” says Anshuman Jaswal, Celent analyst and author of the report. “Importantly, from a regulatory point of view, there should not be a penalty for using nonstandardized CDS because they play a crucial role in the efficient functioning of the credit markets. Also, we need to ensure that there is no confusion due to overlap in regulatory powers of different financial regulators, both nationally and internationally.”

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned subsidiary of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

North America
Michele Pace
mpace@celent.com
Tel: +1 212 345 1366

Europe (London)
Chris Williams
cwilliams@celent.com
Tel: +44 (0)782 448 3336

Asia (Tokyo)
Yumi Nagaoka
ynagaoka@celent.com
Tel.: +81 3 3500 3023

Table of Contents

Executive Summary

3

Introduction

6

Market Overview

9

 

Market Structure and Dynamics

10

 

Comparison of Data Sources

15

Managing Counterparty Risk and Systemic Imbalances

16

 

Recent Industry Responses and Measures

16

 

Penalty for Nonstandardization?

17

 

Collateral Management

17

 

Portfolio Reconciliation and Portfolio Compression

19

 

Capital Requirements

20

 

Trade Reporting and Central Data Repository

20

 

Better Measures of Risk Are Needed

21

 

Annual Reports Need to Be Strengthened

22

 

Change in Basel II Norms

22

 

Reduce Offsetting

23

 

Transactions with Affiliates

23

 

Central Counterparty (CCP) Clearing

24

 

Transparency Requirements

24

 

Harmonization of Regulation

25

 

Oversight of Credit Rating Agencies (CRAs)

25

 

Disclosures for CDS Similar to Corporate Bonds Under TRACE

25

Conclusion

27

Leveraging Celent’s Expertise

29

 

Support for Financial Institutions

29

 

Support for Vendors

29

Related Celent Research

30

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