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Credit Default Swap (CDS)? Volumes Decreasing

Credit Default Swaps act as insurance for mortgages and bond defaults. Reduction in contract volume is considered positive since it should increase transparency. This reduction in contract volume is also known as compression.

The Bank of International Settlement reported that the volume of credit-default-swap contracts outstanding fell in the first half of 2008 in their November report “Monetary and Economic Department OTC derivatives market activity in the first half of 2008″. The following section is section I.1 from this report:

CDS volumes decline (November BIS report Monetary and Economic Department OTC derivatives market activity in the first half of 2008.)

CDS volumes decline for the first period ever since publication of the statistics began in December 2004, the notional amounts outstanding of CDS contracts saw a decline of 1% compared with the notional amounts outstanding at the end of 2007 (Graph 1 and Table 4). Despite the decline in outstanding volumes, the gross market value for CDS contracts increased by 58%. Gross market values rose for both single- and multi-name contracts.

While single-name CDS contracts grew by 3% to $33.3 trillion, the outstanding volume of multi-name? CDS contracts, a category that includes CDS indices and CDS index tranches,declined for the first time since publication began in December 2004. The outstanding amount of multi-name CDS contracts decreased by 6.5% to $24.0 trillion in the first half of 2008.

The decline to a large extent reflects early agreed terminations or netting of outstanding CDS contracts. Multilateral terminations have had a substantial effect on the size of the CDS market in recent years. This trend continued with increased strength in the first half of 2008, when contracts totaling $17.4 trillion were terminated, mainly in the multi-name segment. This reduced the rate of increase in the outstanding amounts by nearly 30 percentage points.

NEW YORK, Friday, October 31, 2008 - The International Swaps and Derivatives Association, Inc. (ISDA) today applauded a number of industry initiatives that have had the beneficial effect of reducing notional amounts outstanding in credit default swaps (CDS), significantly reducing operational, legal and capital costs for industry participants and improving operational efficiency in CDS.

In 2008, efforts to reduce notional outstanding amounts have been rewarded by a decrease of over $25 trillion in CDS notionals. This reflects a range of activities, including compression exercises run by Trioptima, Creditex and Markit. In addition, auctions and settlements of the recent series of credit events, including Fannie Mae, Freddie Mac and Lehman Brothers, have proceeded smoothly.

This year to date, Trioptima has reduced by $24.5 trillion the amount of CDS notional outstanding through its series of compression cycles (also known as tear-ups), which have included index, tranche and single-name trades.Trioptima’s tri Reduce Credit service has been in effect since2005.

Additional efforts implemented by Creditex and Markit that focus on the single name space began as recently as September now account for $550 billion in compressions.

“This reduction innotionals is major progress by anyone’s standards, “said ISDA Chairman Eraj Shirvani, Co-Head of Credit Sales and Trading at Credit Suisse.” That we have been able to reduce outstanding CDS by more than $25 trillion during this period of immense growth and activity for our products is testament to the will and force behind the industry’s efforts to keep operational issues firmly in check.”

“Notional outstanding are often misunderstood,? said Robert Pickel, Chief Executive Officer of ISDA. “While they tend to give an exaggerated impression of amount sat risk, reducing notionals helps both front and back offices. Canceling out economically offsetting transactions reduces the cost and operational workload of managing those transactions.”

According to ISDA’s semi-annual survey to mid-year 2008, the notional amount outstanding of credit default swaps (CDS) decreased by 12 percent in the first six months of the year to $54.6 trillion from $62.2 trillion. For the same period,Trioptima reported $17.4 trillion in completed CDS tear-ups.Subsequent notional reductions would bring CDS notional outstanding to $46.95 trillion before accounting for new trades since July 1,2008.

The notional principal, or notional amount, of a derivative contract is a hypothetical underlying quantity upon which interest rate or other payment obligations are calculated. Notional amounts are an approximate measure of derivatives?activity and reflect the size of the field of existing transactions. For CDS this represents the face value of bonds and loans on which participants have written protection.

The following sections are for reads those who wish to know more about the International Swap and Derivative Association (ISDA) and the International Settlement Bank (BIS). The about pages from their web sites are provided below.

About ISDA

ISDA, which represents participants in the privately negotiated derivatives industry, is the largest global financial trade association, by number of member firms. ISDA waschartered in 1985, and today has over 850 member institutions from 57 countries on six continents. These members include most of the world’s major institutions that deal in privately negotiated derivatives, as well as many of the businesses, governmental entities and other end users that rely on over-the-counter derivatives to manage efficiently the financial market risks inherent in their core economic activities.

Since its inception, ISDA has pioneered efforts to identify and reduce the sources of risk in the derivatives and risk management business. Among its most notable accomplishments are: developing the ISDA Master Agreement; publishing a wide range of related documentation materials and instruments covering avariety of transaction types; producing legal opinions on the enforce ability of netting and collateral arrangements (available only to ISDA members); securing recognition of the risk-reducing effects of netting in determining capital requirements; promoting sound risk management practices, and advancing the understanding and treatment of derivatives and risk management from public policy and regulatory capital perspectives.

About BIS

The Bank for International Settlements (BIS) is an international organization which fosters international monetary and financial cooperation and serves as a bank for central banks. The BIS fulfills this mandate by acting as: a forum to promote discussion and policy analysis among central banks and within the international financial community a centre for economic and monetary research a prime counterparty for central banks in their financial transactions agent or trustee in connection with international financial operations The head office is in Basel, Switzerland and there are two representative offices: in the Hong Kong Special Administrative Region of the People’s Republic of China and in Mexico City. Established on 17 May 1930, the BIS is the world’s oldest international financial organization. As its customers are central banks and international organisations, the BIS does not accept deposits from, or provide financial services to, private individuals or corporate entities. The BIS strongly advises caution against fraudulent schemes.

The establishment of the BIS

The Bank for International Settlements was established in 1930. It is the world’s oldest international financial institution and remains the principal centre for international central bank cooperation.

The BIS was established in the context of the Young Plan (1930), which dealt with the issue of there reparation payments imposed on Germany by the Treaty of Versailles following the First World War. The new bank was to take over the functions previously performed by the Agent General for Reparations in Berlin: collection, administration and distribution of the annuities payable as reparations. The Bank’s name is derived from this original role. The BIS was also created to act as a trustee for the Dawes and Young Loans (international loans issued to finance reparations) and to promote central bank cooperation in general.

The reparations issue quickly faded, focusing the Bank’s activities entirely on cooperation among central banks and, increasingly, other agencies in pursuit of monetary and financial stability.

The changing role of the BIS

Since 1930, central bank cooperation at the BIS has taken place through the regular meetings in Basel of central bank Governors and experts from central banks and other agencies.In support of this cooperation, the Bank has developed its own research in financial and monetary economics and makes an important contribution to the collection, compilation and dissemination of economic and financial statistics.

In the monetary policy field, cooperation at the BIS in the immediate aftermath of the Second World War and until the early 1970s focused on implementing and defending the Bretton Woods system. In the 1970s and 1980s, the focus was on managing cross-border capital flows following the oil crises and the international debt crisis. The 1970s crisis also brought the issue of regulatory supervision of internationally active banks to the fore, resulting in the1988 Basel Capital Accord and its “Basel II ” revision of 2001-06. More recently, the issue of financial stability in the wake of economic integration and globalization, as highlighted by the 1997 Asian crisis, has received a lot of attention.

Apart from fostering monetary policy cooperation, the BIS has always performed “traditional” banking functions for the central bank community (eg gold and foreign exchange transactions), as well as trustee and agency functions. The BIS was the agent for the European Payments Union (EPU, 1950-58), helping the European currencies restore convertibility after the Second World War. Similarly, the BIS has acted as the agent for various European exchange rate arrangements, including the European Monetary System (EMS, 1979-94) which preceded the move to a single currency.

Finally, the BIS has also provided or organized emergency financing to support the international monetary system when needed. During the 1931-33 financial crisis, the BIS organized support credits for both the Austrian and German central banks. Inthe 1960s, the BIS arranged special support credits for the French franc(1968), and two so-called Group Arrangements (1966 and 1968) to support sterling. More recently, the BIS has provided finance in the context -led stabilization programmes (eg for Mexico in 1982 and Brazil in 1998).

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