Credit Default Swap Market Needs Central Clearinghouse: Fitch

Corporate single-name and index credit default swaps (CDS) remained resilient in ’08 and so far in ’09, despite credit events, according to a credit policy special report released Thursday by Fitch Ratings. Initiatives to standardize the CDx market aim to make it even less susceptible to credit market events. One such initiative, the clearing of single-name contracts and indices through a central counter party, is a necessary first step in reducing overall concentrated risk, Fitch said. “In some respects, the CDx market was at the heart of the credit crisis,” Fitch analysts said in the report. “Therefore, it is not surprising that the notional amount outstanding of CDS contracts actually declined by 27% to $41.9trn at year?end 2008 from $57.9trn in the previous year… .” The analysts added: “The decline is to a large extent a reflection of the compression of CDS agreements by netting of outstanding multilateral contracts, but is also influenced by the severe dislocation in the credit markets. Although notional numbers are a simple and consistent measure of the size of the market and level of activity, they are not a true measure of risk.” The ratings agency surveyed 26 banks to find 30% of respondents indicated they anticipate growth of the CDx market. None of them anticipate growth surpassing the 11% to 25% range. Another 30% of respondents indicated anticipated declines of the market in excess of 25%. The negative outlooks on the CDx market mark a shift from results gathered last year, Fitch said. The ratings agency noted $13.8trn of sold CDx contracts at year-end 2008 and $13.9trn of protection bought. “As the buying and selling of CDS contracts is relatively well balanced for these 26 institutions, it is very difficult to establish whether they have been using credit derivatives as a tool to mitigate default risk, particularly as outstanding net CDS exposures are still not a significant percentage of their loan books.” Write to Diana Golobay.

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