Most institutional investors expect another failure of a major financial services firm in the coming year and view credit default swaps as a serious threat to market stability, according to a survey by Greenwich Associates.
Nearly 60 percent of 146 institutions surveyed in North America and Europe expect another major financial services firm to collapse in the next six months, and another 15 percent think it will happen in six to 12 months, according to the survey, which was released on Tuesday.
Credit default swaps, which are used to hedge against the default of a debt issuer or speculate on its credit quality, are viewed by almost 85 percent of U.S. respondents and more than 55 percent of European institutions as a serious threat to global markets, Greenwich said.
Concerns over the health of credit default swap counterparties led 62 percent of fixed income investors to limit their use of the contracts, the survey found.
The U.S. Federal Reserve organized a rescue of Bear Stearns in March on concerns its failure could have sparked a systemic meltdown in financial markets, given the size of Bear's role as a counterparty in the CDS market.
As losses in bad mortgage debt and other securities mount, investors view a similar failure as likely.
"If you are looking for a silver lining in these findings, it seems that most institutions think we are currently in the most dangerous period for global financial services firms," Greenwich Associates consultant Frank Feenstra said in the report.
"Perhaps if the markets can make it through the next six months, the level of pessimism may begin to subside," he added.
More than 70 percent of fixed income investors said they managed counterparty risks by trading only with the most financially sound banks and broker dealers, and 65 percent said they try to limit the concentration of exposure with a single counterparty, Greenwich said.
Three-quarters of survey respondents said they believe plans by a group of dealers to create a centralized clearing entity will mitigate CDS counterparty risk, though the majority of hedge funds said they would prefer a clearing platform operated by an exchange.
Investors also reported their banks have tightened margin or collateral requirements since the credit crunch began a year ago, though nearly 65 percent of investors said this had not had a significant impact on their trading activities.
The Greenwich Associates survey included 32 hedge funds and 114 banks and investors who only take "long" positions. Seventy percent of respondents are in the United States, with others in Canada and Europe.