Credit default swaps. International Swaps and Derivatives Association

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Credit default swaps don't have a very good reputation among finance officials. Opinions have repeatedly been voiced that CDS distort the economic picture in a negative direction. What is it and why is the increase in their value so much of concern to market participants?

History of Appearance

The very first credit default swap in history appeared in 1990 thanks to the joint efforts of specialists from Bankers Trust and JP Morgan. The need for its appearance was due to risk protection on large corporate loans that were provided to the company's clients. Initially, the instrument had a relatively small volume, then by the end of the 1990s it was already equal to several hundred billion dollars, and now it has rapidly grown to 28 trillion dollars.

What role do they play?

In layman's terms, a credit default swap is a special form of bond insurance that allows the buyer to transfer risk to the investordefault of the borrower on interest payments. Prices for such insurance are measured in hundredths of a percent or in basis points.

For example, if a credit default swap is trading at 100 basis points, that means protecting 10 million dollars of bonds would be worth 10,000. Such a transaction (swap) provides a certain guarantee at a favorable cost.

How does it work?

Each of the European origin credit default swaps is created under a "master agreement" that was issued by the International Swaps and Derivatives Association (ISDA). It brings together all the largest investment banks, as well as other investors in over-the-counter derivatives. Such terms are very important because credit default swaps are not available on organized exchanges. At their core, they act as the result of an agreement between sellers and buyers, which are investors and investment banks.

How does CDS work?

The International Swaps and Derivatives Association has five committees of regional importance, consisting of large investors and banks. This is due to the fact that the concept of a credit event and default is rather difficult to define. The above committees are the final arbiters in this matter.

It works like this. Any investor has the opportunity to send a request to the committee, which will be accepted without fail. Next, the question ofwhether a credit event is occurring and whether a transaction can be completed.

Swap in today's economy - what can go wrong?

Because this financial instrument is contractual, there are too many factors to consider and too many instructions. The most important component is that credit default swaps are imputedly based on the borrower or asset. If the underlying asset has changed its name, the consequence may be a refusal to pay the CDS. A large number of investors faced this circumstance during the financial crisis, when some large banks went bankrupt.

Today, most investors are interested in finding new generation financial instruments to invest their resources. This is the reason for the growing popularity of credit default swaps. According to experts, the credit default swap is of great importance in today's environment.

CDS in the US

During recent years, credit default swaps have become the most popular in the US, due to a sharp increase in credit risks. Since this instrument is not under the control of exchanges or government agencies, it is impossible to obtain reliable information regarding the volume of their turnover. As ISDA assesses this situation, hedge funds traded most actively in credit default swaps after the 2008 crisis, and now the situation iswavy.

Previously, financiers from around the world practiced numerous speculations regarding credit default swaps. The result of these actions was the collapse of some significant financial institutions. Many large banks and insurance companies have actually gone bankrupt due to CDS transactions.

Credit default swap in Russia

Let's take a look at what's going on today. Note that in Russia credit default swaps have not gained the same popularity as abroad. This is explained by some problems that need to be solved with the help of the experience of other countries. Since credit default swap trading has been a gradual development, it is somewhat difficult to spread them on the market in Russia.

The main factor hindering the spread of CDS in Russia is the peculiarities of the structure of the borrowing market. In fact, it turns out that the demand for credit resources significantly outstrips supply, and this gives banks the opportunity to set their own conditions regarding rates and terms. The Russian borrowing market has a certain trend associated with the development of short-term loans offering a fixed rate. In turn, the floating rate is present only in loans issued for long periods (from one year or more), and such loans can only be provided to borrowers with a good credit history. In addition, only large banks are engaged in this. All this indicates that there are problems regarding risk hedging.changes. In addition, the qualitative formation of the CDS market in Russia may be hindered by derivatives speculation, which has already been observed in other countries and had negative consequences.

Despite the fact that the assessment of credit default swaps, as well as their reputation, is very ambiguous, participants in the Russian financial market are optimistic about their distribution. This is understandable, since debt holders will be able to minimize credit risks, as well as release funds reserved for loans. This will be possible due to the fact that after the purchase of the swap, the risk of non-repayment of funds will be borne by a third party. All this in the future can increase the liquidity of the debt market as a whole. Sellers, in turn, will have the opportunity to earn extra money by issuing derivatives.

The conclusion from all this can be the following: credit default swaps can be successfully introduced into the Russian market, but for this it will be necessary to carefully regulate and systematize their trade. In addition, it is also necessary to create conditions for the emergence of mass interest in CDS as a quality hedging instrument against default, and not as an object of speculative resale.