The European Systemic Risk Board (ESRB) and the International Organisation of Securities Commissions (IOSCO) have published two complementary reports on single-name credit default swaps (CDS). When read together, the two papers present a comprehensive analysis of the market for these products.
IOSCO’s report, titled “Single-name credit default swaps market”, looks at the global single-name CDS market and recent concerns that have been brought up about its limited transparency and liquidity.
The report presents detailed descriptions of different post-trade transparency requirements for single-name CDS transactions in the EU, UK, and US. It also surveys other jurisdictions outside these regions, including Canada, Switzerland, Australia, Hong Kong, Japan, and Singapore. It observes that the surveyed jurisdictions outside of the EU, UK, and US do not have post-trade transparency requirements for single-name CDS contracts and that US transparency requirements do not appear to have a negative impact on liquidity.
Taking the good with bad
The information gathered was used to assess current levels of post-trade transparency in member jurisdictions and the pros and cons of measures to encourage greater transparency.
Benefits of increasing transparency include reduced information asymmetries, better price efficiency, and reduced regulatory arbitrage. Disadvantages include increased costs of hedging, exacerbated market volatility, and reduced access to financing.
IOSCO concludes that each member should “take steps toward enhancing post-trade transparency in the single-name CDS market in its jurisdiction should they conclude that such efforts would not have a substantial negative effect on market risk exposure or market activity”.
Policies as solutions
ESRB’s report, titled “Credit default swaps – analysis and policies” acknowledges issues with concentration, transparency, and liquidity in the single-name CDS market. To address these concerns, it proposes four policy measures:
• Enhance post-trade transparency for single-name CDS – this can be achieved by adjusting the EU’s post-trade transparency regime to apply to single-name CDSs on EU’s globally systemic banks and EU sovereigns.
• Strengthen supervisory access to information – this can be achieved through standardisation of reported data and better global cooperation. The report proposes the development of a real-time monitoring tool for CDS markets “to enable timely macroprudential interventions during periods of systemic market stress”.
• Promote the efficiency and functioning of the single-name CDS market – this can be achieved by identifying and addressing structural factors limiting demand, supply, and competition in the single-name CDS market.
• Improve credit risk assessment frameworks – this can be achieved by reducing excessive reliance on CDS spread and raising awareness of the price formation mechanisms. The report suggests that “policymakers, market participants, and other stakeholders should deepen their understanding of, and consider the structural limitations associated with single-name CDS pricing, particularly under conditions of market stress”.
