CDS Markets Should Be More Transparent
Other countries have been urged to increase post-trade transparency in the credit default swap market after mandatory disclosure in the United States was found to have no impact on market activity.
Buyers of CDS contracts are protected against negative credit events such as a downgrade or default through receiving a payment from the seller. As the risk of a downgrade or default increases, buying protection becomes more expensive.
This month the International Organization of Securities Commissions published a report, Post-Trade Transparency in the Credit Default Swaps Market, which analysed CDS transactions before and after the introduction of mandatory post-trade transparency in the CDS index market in the US.
Since December 2012 CFTC regulations in the US have required the disclosure of the price and volume, but not the counterparty, of each relevant transaction and the data is widely accessible. The lack of transparency in the CDS market has been cited as one causes of the 2008 financial crisis.
The Iosco report said: “Iosco concludes that greater post-trade transparency in the CDS market – including making the price and volume of individual transactions publicly available – would be valuable to market participants and other market observers. Iosco encourages each member jurisdiction to take steps toward enhancing post-trade transparency in its CDS market.”
Amir Khwaja, chief executive of Clarus Financial Technology, said on the company’s blog that only the US has implemented disclosure for CDS index-based products. Khwaja said the US SEC has rules for single-name CDS products but no compliance schedule. Canada will start reporting at the end of July 2016, Europe in January 2017 under MiFID II and in Japan exchange-traded products will be required to report next year.
Khwaja said: “The benefits of transparency to us are obvious: better price discovery, less asymmetry of information, leading to a more efficient market with greater competition and liquidity just as we have seen in the US corporate bond market after the introduction of Trace.”
Clarus data showed that in the US only 1% of gross notional volume in CDS indexes were not cleared in June this year.
“The transparency benefits are different from and far greater than, the pre-regulatory reform repositories such as the DTCC Trade Information Warehouse,” added Khwaja. “Lets hope that regulators in non-US jurisdictions get the message and implement similar rules. Not to do so would be a missed opportunity.”
Sviatoslav Rosov, an analyst in the capital markets policy group at the CFA Institute said on the institute’s blog: “We believe and empirical analysis broadly supports that increased transparency benefits market quality for investors. This Iosco report seems to confirm that this is true also of CDS markets.”
The Bank for International Settlements estimated that $16 trillion in notional amounts were outstanding in the CDS market at the end of last year, down from its 2007 peak of approximately $60 trillion. Increased transparency and central clearing could help boost liquidity and trading volumes.
In June LCH.Clearnet, a subsidiary of the London Stock Exchange Group, launched clearing of European senior financials credit default swaps – the Markit iTraxx Senior Financials Indies and all 36 single-name constituents of these CDS indices.
US regulations began to make CDS clearing mandatory in 2013. In Europe mandatory clearing of CDS is expected to begin for banks next summer and for buy-side clients towards the end of 2016.
Clarus Financial Technology data in April found that US dealers were pricing cleared CDS more aggressively than bilateral trades due to increased capital costs – which should drive more firms to clear voluntarily.
Clarus said: “As more firms clear, more dealers will make markets in single name CDS. As the cleared swap world grows, you’ll start to find a healthy swap execution facility (or SEF-like) market for single name CDS.”
Feature image by Bluebay2014/Dollar Photo Club
Phase 5 of the uncleared margin rules (UMR) took effect from September 2021.
Temporary equivalence is set to expire on June 30 2022.
IRS trading volumes have fragmented without an equivalence agreement.
Phase 5 of the uncleared margin rules came into effect on 1 September.
Triparty repos can be executed across U.S. Treasury securities to central clearing.