On September 27th, the Federal Reserve Bank of New York published a staff report, titled An Analysis of CDS Transactions: Implications for Public Reporting (the “Fed Report”). The Fed Report analyzed three months of global credit default swap (“CDS”) transaction information (i.e., May through July 2010) and presents findings on market composition, trading dynamics and level of standardization. Among other things, the Fed Report was intended to contribute to the development of public reporting requirements and data collection in derivative industry reform efforts.
During the three-month investigation period, the Fed Report found that there were 292,403 transactions (including both single-name and index trades)[1] on 1,554 corporate and 74 sovereign reference entities. Of these, approximately two-thirds were single-name CDS transactions, the vast majority of which were on corporate names. The Fed Report further found that only some 3% of corporate names were “actively traded” (i.e., traded an average of at least 10 times per day during the period) and that CDS transactions tended to be traded in standard notional sizes, with corporate single-names most frequently traded in the $/€5 million mode and indices typically traded in modes of $10 million and $/€25 million. Both single-name and index transactions were most frequently traded in 5-year maturities. Also, 63% of all CDS transactions were between the 14 major over-the-counter derivatives dealers (the “G14”), with the remainder between G14 dealers and end users. Overall, G14 dealers acted as protection sellers 85% of the time and as protection buyers 78% of the time. The Fed Report determined that, on a daily basis, an average of some 3,000 single-name trades were executed for $25 billion of notional value and an average of some 1,450 index trades were executed for $74 billion of notional value.
Based on its examination of this and other trade data, the Fed Report made several conclusions, including that: (i) a high degree of product and trading practice standardization exists in the CDS market (with respect to contractual terms,[2] as well as notional sizes and maturities); (ii) there was no clear differentiation in trade sizes between CDS that were eligible for clearing at the time of investigation and those that were not, suggesting that there may be no reason to treat the two sets of transactions differently for trade reporting rule purposes; and (iii) large customer CDS trades are not hedged by dealers entering into offsetting trades using the same instrument soon thereafter, suggesting that requiring same-day reporting of CDS trading activity may not disrupt same-day hedging activity by dealers (since little such activity occurs),[3] although regulators should gauge the impact such reporting may have on dealers gradually trading out of positions.
[1] The Fed Report observed 57 distinct credit indices, with Europe iTRAXX and CDX North American Investment Grade collectively accounting for 40% of the index market.
[2] Indeed, the report found that, of the single-name contracts it examined, 92% had a fixed coupon and 97% had fixed quarterly payment dates.
[3] As noted in the Fed Report, the dealer community has expressed concern that public knowledge of large transactions (including perhaps through the real-time reporting requirements contemplated by the Dodd-Frank Act) creates the risk that others in the market will front-run dealer attempts to offset those transactions, hence increasing the cost of hedging.