GO
Loading...

Credit Default Swaps Are 'Scapegoat': Industry Body

Credit default swaps (CDSs) have emerged blinking from computers in glass-fronted offices into the limelight in recent years.

CNBC.com

The financial instruments, which protect against debt defaults, have acquired an almost mythical status as part of the cause of the financial crisis, particularly in the collapse of Lehman Brothers.

In recent weeks, they have come back into focus as CDS spreads on Greek debt hit stratospheric levels, fueling fears that the debt-ridden Mediterranean economy might suffer a similar fate to Lehman's.

In the European Union there has even been talk of a ban on "naked" CDS - where a trader buys a CDS without holding the sovereign bonds, hoping that the country will default and the insurance contract will pay out - after fears that they helped raise bond yields in countries like Greece and Italy.

There are also concerns about short-selling within the CDS market, and the US is considering new rules to report trading in CDSs on the day it happens as part of the Dodd-Frank proposals, which set out new rules aimed at avoiding another financial crisis.

David Geen, European General Counsel at the International Swaps and Derivatives Association, the trade association for over-the-counter derivatives, told CNBC Monday that he believes CDS spreads are a reflection of "how the market sees Greece" rather than anything more sinister.

The total net notional daily margined risk exposure on Greek debt as of September 23 was around $3.9 billion, according to the Depositary Trust & Clearing Corporation (DTCC).

"When you look at the amount of Greek debt this is less than 1 percent," said Geen.

"The tail's not wagging the dog here. CDSs have become something to focus on as a scapegoat."

"The actual numbers that you make if Greece was to default are probably very small," he said.

"The market would not pay so much attention to these levels if they were not meaningful," Sean Corrigan, Chief Investment Strategist at Diapason Commodities Management, told CNBC Monday.

"It's the naked buyers not the naked sellers who cause the trouble. Look at the American crisis – it was AIG as much as anybody, because they underwrote this for years."

A recent report by Germany’s centre for economic research (ZEW), commissioned by the European Parliament’s Economic and Monetary Affairs Committee, concluded: "Prohibiting naked CDS transactions, as proposed, would have detrimental effects on the liquidity as the market is left only to hedgers…Valuing credit risks will become more difficult."

Geen maintained that CDS trade is much more "meaningful" for corporate than sovereign debt.

"One of the problems is how do we know who's hedging and who’s not. We don't know and insuring these things and who's hedging and who's speculating are very hard to do," he said.

"It's not the shortsellers that are causing the problem, it's the fundamentals and maybe shortsellers are implying where the problem is. That's what happened with Lehman."

Banks