Monday, January 12, 2009

Notional lipstick on the CDS pig

(It doesn't appear that risk is being reduced save for perhaps 'operational risk' in that backoffice can more easily manage trades. Notional reduction does not change risk profile, this appears to be merely cosmetic for the great unwashed - AM)

31 Oct 2008, 2306 hrs IST, REUTERS

LONDON: Efforts to make the credit derivatives market more efficient have shrunk the volume of outstanding contracts by $25 trillion so far this year, the International Swaps and Derivatives Association said on Friday.

In a practice known as portfolio compression, banks replace hundreds of outstanding credit default swaps (CDS) on the same company that offset each other with a single swap, making portfolios simpler and easier to manage. (Another definition of compression is ending existing CDS trades and replacing them with a smaller number of trades that leave a portfolio with the same risk profile - AM)

TriOptima, a Swedish company that provides a service helping parties compress trades, accounted for $24.5 trillion of the decrease, and Markit and Creditex, which began offering a competing service in September, for another $550 billion, ISDA said.

The market's high notional trade numbers tend to give an exaggerated impression of what is at risk (and conversely reducing notional gives an exaggerated impression of reducing risk - AM), said Robert Pickel, ISDA chief executive in a statement. "Cancelling out economically offsetting transactions reduces the costs and operational workload of managing those transactions." The notional amount of outstanding CDS decreased by 12 percent in the first six months of 2008 to $54.6 trillion from $62.2 trillion, due largely to compression, said ISDA.

Subsequent efforts would bring the outstanding amount to about $47 trillion, not counting new trades since June, the association said. TriOptima said it had offered the market 39 compression cycles since the start of 2008 and will offer nine more cycles in November and December this year.

Compression cycles are a series of meetings between the company and interested market participants, where the parties can discuss and agree the terms of a deal.

According to ISDA's semi-annual survey to mid-year 2008, the notional amount outstanding of credit default swaps (CDS) decreased by 12 percent in the first six months of the year to $54.6 trillion from $62.2 trillion. For the same period, Trioptima reported $17.4 trillion in completed CDS tear-ups. Subsequent notional reductions would bring CDS notional outstandings to $46.95 trillion before accounting for new trades since July 1, 2008.

The notional principal, or notional amount, of a derivative contract is a hypothetical underlying quantity upon which interest rate or other payment obligations are calculated. Notional amounts are an approximate measure of derivatives activity and reflect the size of the field of existing transactions. For CDS this represents the face value of bonds and loans on which participants have written protection.

By Paul J Davies in London
Published: January 12 2009 02:00
Financial Times

Big investment banks ripped up more than $30,000bn worth of credit derivatives last year, or almost half the record total outstanding at the start of 2008, as they aggressively pursued efforts to tidy up the industry.

Banks' efforts to clean up credit default swaps began with modernising and speeding up the processing and confirmation of trades, then moved last year into pruning the large volumes of older, outstanding trades. The $30,000bn excised from the market last year was three times the $10,000bn taken out in 2007.

The first half of last year saw the first decline in outstanding notional volumes, which shrank from $62,300bn to $54,600bn by June 30 2008, according to the International Swaps and Derivatives Association, the main lobby group for the industry.

No comments: