ISDA®
INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, INC.
NEWS RELEASE
For Immediate Release, Monday, March 15, 2010
For More Information, Please
Contact:
Deirdre Leahy, ISDA New York, +1
212-901-6021, dleahy@isda.org
Donna Chan, ISDA Hong Kong, +852
2200 5906, dchan@isda.org
ISDA Comments on Sovereign CDS
NEW
YORK, Monday, March 15, 2010 – The International Swaps and
Derivatives Association, Inc. (ISDA) today issued the following statement
regarding credit default swaps (CDS) on sovereign reference entities.
There has been a significant
amount of attention in the last several days regarding sovereign CDS and the
extent to which naked sovereign CDS are dictating the prices of the underlying
bond markets. This discussion has led some to propose that naked sovereign CDS
be banned or suspended. ISDA wishes to address certain issues in this debate:
market and instrument transparency, outstanding sovereign CDS volumes and the
possible impact of sovereign CDS on the underlying Greek government bond
market.
Critics of the CDS market assert
that the market is complex and opaque. At the same time, the critics argue
that, despite its complexity and opaqueness, the CDS market is liquid enough to
influence markets of enormous size. ISDA believes this line of reasoning is
flawed and inconsistent.
ISDA believes that the most
commonly traded CDS, including sovereign CDS, are simple and relatively liquid.
At the same time, the market for sovereign CDS is much smaller than the
underlying market for government bonds.
It is also ISDA’s view that the
CDS market is far from opaque. Market participants and the general public have
ready access to data to evaluate market activity. The amount of outstanding CDS
and weekly transaction activity for the 1,000 largest names (including
sovereign CDS) are publicly available through the website of DTCC`s Trade
Information Warehouse (www.dtcc.com/products/derivserv/data/index.php).
In addition, policymakers have access to transaction level data to evaluate
market activity.
Outstanding
Sovereign CDS Volumes
The table at the bottom of this release
shows the most recent net outstanding CDS positions for the largest sovereign
names, with a net position of $9 billion for the Hellenic Republic.
Examination of DTCC’s reports since the
beginning of 2010 shows the net outstanding CDS position on the Hellenic
Republic has changed little over the course of this year. The net position for Greece was $8.7 billion
in the week of January 1, 2010 and has ranged between $8.5 billion and $9.2
billion since then. Furthermore, the
DTCC data indicates the net position for Greece was $7.4 billion a year ago.
None of the data suggests there has been a surge of open interest in either
2009 or 2010.
The activity and outstanding
volumes in the Greek CDS market need to be contrasted with the outstanding
volumes in the Greek government bond market, which exceeds $400 billion. None
of the data can possibly lead to a conclusion that a market of $9 billion can
dictate prices in the $400 billion government market.
Indeed, if prices in the CDS
market widened significantly relative to the Greek government market,
arbitrageurs and holders of Greek government bonds would simply sell the bonds
and write protection in the form of the sovereign CDS. The fact that government
bond and CDS spreads have remained essentially in line while outstanding
positions have remained constant underlies our assertion that the CDS market
has had little or no impact on the government market.
It is important to understand
that Greek CDS are useful for controlling risk for investors and lenders. Greek
CDS provide effective hedges not only for holders of Greek government bonds but
also for international banks that extend credit to Greek corporations and
banks, for investors in Greek stocks and for entities that have significant
real estate or corporate holdings in Greece. For many of these participants,
the sovereign CDS market is the most effective means of hedging credit risk in
Greece. Recent anecdotal evidence indicates that banks with significant credit
exposure to entities in Greece have been active purchasers of Greek sovereign
CDS protection. Much of this activity
could be misinterpreted as “naked CDS.”
ISDA further believes that this activity cannot have any significant
impact on Greek government prices because of its insignificant size in relation
to the underlying government bond market.
Recently, a simplistic analogy
has surfaced and been repeated that compares CDS to fire insurance. People who use this analogy point to
insurance law prohibiting individuals from buying insurance on a neighbor`s
house so that they will not burn it down to collect the insurance
proceeds. Under this analogy, writing
naked CDS is equivalent to buying such insurance and committing arson and
should therefore be banned.
The analogy leaves some important
points unsaid: How, for example, can buyers of naked CDS actually burn down the
house? It is important to remember that
for every buyer of CDS there is a corresponding seller who benefits when the
reference entity’s credit quality improves.
It is unclear how such activity alone can lead to a default by a
sovereign government on bonds it has issued.
Such claims ignore the commonsense facts available and fail to show
either cause or effect. These claims
also ignore short selling activity in Greek government bonds, which certainly
has a greater effect on Greek bond prices as it involves selling the actual
instruments in the market.
ISDA supports the efforts of
global policymakers in examining the CDS and other derivatives markets to
ensure they are safe and efficient. ISDA believes policymakers should have the
supervisory tools and authority to take action should any abuses be found in
the operations of any financial market.
ISDA,
which represents participants in the privately negotiated derivatives industry,
is among the world’s largest global financial trade associations as measured by
number of member firms. ISDA was chartered in 1985, and today has over 810
member institutions from 57 countries on six continents. These members include
most of the world’s major institutions that deal in privately negotiated
derivatives, as well as many of the businesses, governmental entities and other
end users that rely on over-the-counter derivatives to manage efficiently the
financial market risks inherent in their core economic activities.
Information about ISDA and its activities is available on the Association's web
site: www.isda.org.
ISDA® is a
registered trademark of the International Swaps & Derivatives Association,
Inc.
Sovereign Reference Entity Net
Notional
Republic
of Italy: $26
billion
Kingdom
of Spain: $16
billion
Federal
Republic of Germany: $13
billion
Federative
Republic of Brazil: $12 billion
Portuguese
Republic: $ 9 billion
Republic
of Austria $ 9 billion
French
Republic $ 9 billion
Hellenic
Republic $ 9 billion
(Note: data is of February 27th. Net notional represents the maximum possible
net funds transfer (excluding any recoveries) between net sellers of protection
and net buyers of protection that could be required upon the occurrence of a
reference entity credit event. The
industry uses net notional rather than gross notional as most contracts remain
outstanding even as risk is offset. For example, if a client writes or buys
protection through a CDS, the client will typically use a dealer and the dealer
making the price to the client will very often trade a CDS with another dealer
to offset its position. This dealer, in
turn, may lay off its position with another dealer. Thus the gross position increase but the
actual risk is the amount of the original transaction.