Wall Street & Technology is part of the Informa Tech Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 8860726.

Compliance

10:40 AM
Kevin McPartland, Tabb Group
Kevin McPartland, Tabb Group
Commentary
50%
50%

Credit Default Swaps Are Not 'Evil'

It's time to take CDSs off the list of investment instruments of which we dare not speak.

If Congress really had its way (well, Democrats anyway) all swaps would look and trade like futures. And if your days involve trading or processing either, you already know that this situation presents a classic square peg/round hole problem.

Case in point: Eurex launched iTraxx futures in 2006 and no liquidity ever developed. But times have changed, and although I'm not completely convinced the world needs credit-default-swap (CDS) futures, the upside if the contracts are successful is big enough that it is nearly inevitable that these products will come to market ahead of CDS trading and clearing mandates later in 2012. Why?

To begin with, clearinghouse margin requirements for CDSs are considered by many market pros as unnecessarily high. Complications related to clearing sovereign and bank CDSs — two of the most highly used CDS segments — will leave margin requirements for those products even higher than for index CDSs. These high-margin requirements alone could open the door for CDS futures, as the margin requirements for futures are tracking much lower than for comparable swaps.

Second, credit is a pretty fascinating market these days. I wouldn't go so far as to say it's a good market, given all of the turmoil and volatility; but for those whose investment strategies rely on turmoil and volatility, new instruments that make it easier to bet on the creditworthiness of a company or country could draw serious demand.


Slamming the Brakes on HFTFearful that high-speed traders are out of control, the SEC is prepared to implement curbs to slow down high-frequency trading. Download our March 2012 digital issue now.

Futures contracts would allow smaller players investing smaller amounts of money into the space. The average CDS trade is roughly $10 million in notional value. Futures contracts would likely bring that down to $1 million or less. And since only initial margin would be required to open the position, one could take a CDS-like position for between $50,000 and $100,000. Not exactly an appropriate investment for your mom's 401(k), but certainly good for small hedge funds and professional investors.

Success Is No Guarantee

Despite these upside drivers for CDS futures, success is anything but guaranteed. Over the past few weeks the topic of CDS futures has come up more frequently in conversations with industry participants. In fact, we discussed this backstage at Tabb Group's recent Fixed Income Trading 2012 event in New York in January. Everyone agreed that several firms are "working on the problem."

A Tabb Group report estimated that 80 percent of CDX.IG trading in the interdealer market is happening electronically based on a highly standard contract. Remember the Big Bang in 2009? That activity begs the question: With such a standard and relatively liquid market already in place, why do we even need futures? It's really nothing more than a different regulatory rubber stamp calling the product one thing over another.

Previous
1 of 2
Next
More Commentary
A Wild Ride Comes to an End
Covering the financial services technology space for the past 15 years has been a thrilling ride with many ups as downs.
The End of an Era: Farewell to an Icon
After more than two decades of writing for Wall Street & Technology, I am leaving the media brand. It's time to reflect on our mutual history and the road ahead.
Beyond Bitcoin: Why Counterparty Has Won Support From Overstock's Chairman
The combined excitement over the currency and the Blockchain has kept the market capitalization above $4 billion for more than a year. This has attracted both imitators and innovators.
Asset Managers Set Sights on Defragmenting Back-Office Data
Defragmenting back-office data and technology will be a top focus for asset managers in 2015.
4 Mobile Security Predictions for 2015
As we look ahead, mobility is the perfect breeding ground for attacks in 2015.
Register for Wall Street & Technology Newsletters
Video
Stressed Out by Compliance, Reputational Damage & Fines?
Stressed Out by Compliance, Reputational Damage & Fines?
Financial services executives are living in a "regulatory pressure cooker." Here's how executives are preparing for the new compliance requirements.