• July 9th, 2018
• By Midsilver Investment Limited

Over the past ten years, the global credit default swap (CDS) market has undergone significant transformations. Leveraging BIS derivatives data, we highlight how outstanding volumes have declined, central clearing has surged, and the nature of underlying credit risk exposures has transformed. The netting of CDS contracts has grown, driven by a rise in standardized index products and their central clearing. This has further diminished counterparty risks. Underlying credit risks now lean more towards sovereigns and reference securities with superior credit ratings. However, the spread of credit risks among counterparty categories has stayed relatively consistent.

The credit default swap (CDS) market, since its establishment in the early 1990s, witnessed consistent volume growth, which then rapidly amplified leading up to the Great Financial Crisis (GFC) of 2007-09. Due to its significant role in the crisis and its size, there were demands for enhanced transparency and robustness.

Subsequent to this, the market has seen numerous pivotal shifts. Players in the market have cut down their risks and phased out superfluous contracts - a trend initiated pre-GFC but that amplified post-crisis. Reforms post-GFC have encompassed contract standardization, augmented reporting mandates, obligatory central clearing, and margin prerequisites for numerous derivatives.

This analysis, rooted in BIS derivatives information, reviews the evolution of the CDS market from the GFC up to the close of 2017. The focus rests on the latest, continuous changes, particularly the dwindling of inter-dealer positions and the ascendancy of central counterparties (CCPs). Initially, we spotlight the ongoing reduction in outstanding nominal values, contending that post-GFC, this was primarily propelled by contract compression and exposure reduction. Next, we discuss the rise of CCPs, vital in steering recent market shifts. The prevalence of clearing is more pronounced in the multi-name market, with a few CCPs dominating the clearing process. Lastly, we delve into how inherent risks have migrated, positing that the fusion of an escalating share of standardized index products and augmented CCP clearing has contributed to diminished counterparty risks. We also note that credit risks haven't gravitated towards any particular counterparty type.