Shrinking Outstanding CDS

by: Felix Salmon November 25, 2008    
Felix Salmon

Felix Salmon

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Good news on the CDS front: Markit and Creditex are quietly and efficiently netting out contracts, bringing down notional amounts in single names alone by more than $1 trillion at this point.

This is a sensible way to reduce risk in the CDS market: Instead of trying to net out a huge number of contracts in one big session, bring down notionals slowly, week in and week out. Here's the chart showing how many CDS have been compressed on a week-by-week basis: As you can see, if anything the amount is rising over time, with last week seeing a record $224 billion compressed. As this process continues, systemic risk is reduced and positions are helpfully clarified. It's not an alternative to an exchange, but there's a lot to be said for doing something now rather than hoping to do something bigger later.

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This article has 3 comments:

  •  
    Nov 25 01:48 PM
    Can you explain how this is done? It's over my head financially.
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  •  
    Nov 25 02:34 PM
    The notional value of CDS is the entire monetary amount of all contracts for a specific entity. If counterparty A engages with counterparty B who engages with counterparty C, the notional value of the swap contracts will be larger than the amount of real money that actually gets exchanged in the case of a default. The downside to that is that if one of the counterparties also defaults, one of the entities that thought they were covered with protection actually is not, and then they must come up with the payment. That is the systemic risk in the system; luckily the settlements have gone smoothly and losses have been significantly less than what many expected. By compressing contracts, the notional value decreases and the amount of untangling in settlement events will be much less difficult.
    Reply | Link to Comment
  •  
    Nov 26 11:59 AM
    Think of it as the pot getting smaller as more people join ga
    Reply | Link to Comment
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