Wealthy Nations Daily Update - CDS

In a Bloomberg story today questions are raised about the transparency of the Credit-Default Swap (CDS) market and indeed the structure, where the main players in the market are also the umpires.

The CDS market is valued around USD 14 trillion but the concern is that firms, such as JP Morgan and Goldman Sachs Group, who are some of the largest players helped write the rules for the market and are also on the committee who decide whether a default has been triggered and a pay-out is due.

Broadly, there are 15 firms on the committee and after a missed payment they meet in a conference call to discuss if a default has resulted, they basically decide how much money will change hands from the pay out of bond insurance, deciding winners and losers. The committee known as the determinations committee is overseen by the International Swaps & Derivatives Association (ISDA). Concerns are now being raised on the back of recent interest rate and currency fixing scandals as to having the dominant market makers with the authority over an entire market with some saying this structure is open to collusion or even worse manipulation.

ISDA claim the system is transparent and that having both buyers and sellers on the determination committee mitigates conflicts. ISDA’s Chief Executive said, “But like all robust processes, there needs to be continual analysis, feedback and improvement. We will continue to review policies and procedures as market practices adapt.”

The market for credit insurance on individual companies has reportedly shrunk by around 59% since 2008. However, US mutual funds, the sector built on America’s retirement savings, are increasing their use of CDS through benchmark CDS indexes which means the determinations committee is increasingly affecting the USD 3.5 trillion mutual bond fund market.

The determinations committee has reportedly made over 1000 judgments in the last six years; no records have ever been made public, and ISDA is not proposing they should be.