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.


Improved Market Transparency

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 ( 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.


Impact of Naked Sovereign CDS on Greek Government Bond Market

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 Remains Committed to Engaging with Policymakers

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.


About ISDA

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:

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.

Documents (1) for ISDA Comments on Sovereign CDS