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IL riepilogo annuale di ficc sui cds governativi
FT Alphaville A year in the life of sovereign CDS


A year in the life of sovereign CDS

Posted by Joseph Cotterill on Sep 17 17:27. With Ireland spreads widening on Friday, it’s an apt time to turn to Fitch’s latest edition of its annual survey of credit derivative traders.
Not least because it offers some revealing insights on how sovereign CDS contracts are actually used in the market. Or at least, on bank desks:
This year’s survey, which is the seventh conducted by Fitch, includes 29 banks from 10 countries. Note while these participants are a subset of the total number that comprises this market, the institutions covered represent many of the most significant players and underscore past and current trends…
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So no hedge funds or asset managers within this survey.
Of course, at first glance, Fitch’s findings aren’t really that shocking — except for confirming that the CDS market has been blind-sided by the rapid attentions of regulators during the crisis. As the report notes:
Among the bigger surprises noted by several respondents was the extent of blame attributed to CDx [Fitch-ese for credit derivatives] for either causing the market meltdown or otherwise negatively affecting market dynamics, and a seeming lack of understanding of the role/mechanics of CDS in general…
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But this is a bit more interesting (emphasis ours):
Of all surprises related to the past year’s events, those related to sovereigns were among the most prominent. In particular, the growth of the sovereign CDS market in terms of volumes and general relevance was noted by a number of respondents.
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Quite. In fact, 89 per cent of respondents reckoned that use of sovereign CDS would increase in the future.
That’s despite (for instance) new EU regulation targeting short-sellers of sovereign CDS in volatile periods. Or actually — perhaps the interest is because of regulation in other parts of the derivatives market.
Say, requirements for trades to post better or more consistent standards of collateral as a way to control counterparty risk — as part of moves towards centralised clearing.
Except – sovereigns don’t post collateral. That’s a problem for traders, as we’ve previously observed, in agreeing interest rate swaps with sovereigns without collateral protection. They thus have to construct a synthetic hedge via shorting CDS on the sovereign.
That’s a problem for sovereigns, though, because the sovereign CDS market isn’t so liquid that these hedges manage to avoid affecting the credit spread volatility on sovereigns.
And hedging is also (not surprisingly) a popular activity alongside sovereign strategies, according to Fitch’s survey:

Which leads us to something of a conundrum — traders inadvertently help increase volatility in sovereign credit spreads; but according to Fitch, they are surprised when volatility happens:

And yet do believe that sovereign CDS impacts other credit spreads:
Given the increased volatility surrounding certain sovereigns at the time the survey was distributed, most notably Greece and Portugal, Fitch was curious as to the market’s perception of the extent to which CDS trading was influencing cash market spreads for those specific sovereign names. The response in this case was marginally stronger, with a slight majority classifying the impact as at least “Important” with 28% viewing the impact as either “Very Important” or “Critical.”
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So if sovereign CDS trading is going to carry on growing, that’s probably a sound reason for sovereigns to follow Portugal’s lead and think more about ways in which they can post collateral to clearing houses.
 
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