Credittrade sitzt, haben die Amis noch gar nicht mitbekommen, denn das könnt Ihr eigentlich nur bei Libuda lesen, der auf deutschen Boards schon vor 18 Monaten auf die gigantischen Chancen hinwies (indem er dies von der Seite von IBM reinstellte) und auch schon davor:
The rise of the credit derivatives industry
Author: By Adam Josephson, Analyst, Securities and Investments Group, Celent
Issue date: 12 Oct 2004 Issue No:Volume 5 Number 10
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Why risk enterprise risk management
P&C underwriting: the possible
Action stations for insurers
Bank’s Financial Intelligence Quotient
Among the more notable developments in the financial services industry in the past few years has been the remarkable rise of the credit derivatives industry. In the early 1990s, the market was virtually nonexistent; it was not even tracked until 1997. In 2000, the market was valued at approximately US$800 billion notional outstanding, and by 2002 it totaled more than US$2 trillion notional outstanding. Celent expects notional outstanding to exceed US$7 trillion by 2006. Some market participants believe credit derivatives could grow to match the huge interest rate derivatives industry, which is nearly 50 times as large.
Credit derivatives are bilateral contracts that allow users to manage their exposure to credit risk. As with any other derivative instrument, credit derivatives can be used either to take on more risk or avoid (hedge) it. A market participant who is exposed to the credit risk of a corporation can hedge such exposure by buying protection in the credit derivatives market. Likewise, an investor may be willing to take on that risk by selling protection and thus enhancing the expected return on his portfolio. Historically, banks have been most prone to the former, while insurance companies have often done the latter.
Credit derivatives can be used to create positions that would otherwise not easily be established in the cash market. For instance, consider an investor that has a negative view on the future quality of a given corporation. One strategy for such an investor would be to short the bonds issued by the corporation. However, the corporate repo market and other mechanisms for taking short positions in corporations are not well developed for most individual corporate issuers. By buying protection via a credit default swap (the most popular type of credit derivative), the investor essentially mimics the cash flows of a short position in the corporation’s debt. Should the corporation default, the investor can buy the defaulted debt for its recovery value in the open market and sell it to its counterparty for its face value.
These instruments have truly transformed the corporate bond market. Before the advent of credit derivatives, large companies with at least reasonably good credit ratings could issue bonds underwritten by a Wall Street bank to raise money. Fund managers and individuals would buy the bonds and hold them for years, in many cases until maturity. Now, investors don’t have to buy a corporate bond to place a bet on credit. Instead, banks, insurance companies, hedge funds, and asset managers trade credit default swaps (CDS) — derivatives that are now the leading force in setting bond prices — and indices based on those swaps.
Five years ago, credit default swaps were mostly traded among banks that wanted to manage risk exposures on their loan portfolios and gain regulatory capital relief. Trading volumes and volatility increased substantially as insurance companies and hedge funds entered the market, and growth in the past two years has been most attributable to the trading activities of hedge funds and trading desks of investment banks. Insurance companies are net sellers of protection to earn yield on the premiums they collect; they also buy protection to decrease their credit exposure without having to sell their bonds. Hedge funds (and proprietary trading desks at banks) have a rather different agenda. Many are uninterested in the merits of a long-term investment in a company’s bonds. Some engage in capital structure arbitrage, which exploits mispricings between a company’s equity and debt. Others focus on convertible arbitrage, which does the same with convertible bonds and equity. In short, hedge funds take a number of positions that have nothing to do with a company’s overall credit quality.
However, that need not serve as reassurance for companies whose bond yields are volatile. The entities that form the credit derivatives market are quick to spot companies whose credit is less than stellar. Measured over a year, the market is better at predicting defaults than ratings agencies, which can be slow to downgrade companies. Fitch, a ratings agency, pointed out that the spread on CDS suggested there was a 20 percent chance of Sprint’s defaulting in the summer of 2002 even though it had an investment grade rating. Some bankers, in fact, envision that the CDS market will replace the credit ratings agencies because CDS provide a more timely indication of a company’s credit standing than the formal ratings.
A critical element of the developing market for portfolio credit risk has been the growth of trading in credit indices. In an effort to build greater transparency, liquidity and acceptance of CDS, securities dealers created two CDS indices in 2003, TRAC-X and iBoxx. They were based on CDSs on large, equally weighted baskets of names traded in the market. Trading of these indices was robust, but was hampered by the lack of a single market; individually the indices were less liquid and it was unclear whether one would come to dominate the market. That ceased to be a problem in late June, when the two indices merged. DJ iTraxx Europe was introduced and was soon followed by versions for the US and Asia. The merger has led to a dramatic increase in trading volumes. In the month following the merger, volumes rose three - to fourfold in Europe, according to JPMorgan.
Trading has a ways to go yet
Credit derivatives deals have largely been processed manually, and only with improved straight-through processing (STP) and greater standardization will the market be able to become more efficient, and consequently more liquid. Along those lines, the leading dealers in the market have devised a three-year strategy to bring the necessary automation and STP to the derivatives markets, and market participants view these timelines as reasonable. The technology and infrastructure are in place for the automation of trade verification, confirmation, and legal execution, as well as the improved settlement of credit derivatives. Many participants, for instance, are already using the Depository Trust & Clearing Corporation’s automated trade matching and cash flow matching services. The proposed standard for OTC derivatives, FpML, is becoming established for external data exchange, and a host of large dealers in the market already use it in internal systems.
Standardization appears on the horizon as well. Most of the large dealers are using a reference entity database (RED) — a cleaned set of data on credit entities and obligations associated with their bond issues. The database has classified all traded credits, eliminating confusion during trading. The International Swaps and Derivatives Association has brought some standardization to CDS, producing standard templates that market participants can use for their deals and recommending standard processes, such as the quarterly settlement of transactions. Contracts have now been reduced to a standard structure, making them far easier to process manually and introducing the possibility of electronic processing. Equally important are the standard processes that have been introduced. Unlike in previous years, market participants adhere to standard maturity dates for the index products. Eventually the most liquid CDSs will be standardized as well, leading to a more liquid market.
A natural byproduct of the increased automation and standardization of the market has been the introduction of electronic trading. The inter-dealer broker Creditex launched an electronic trading platform for credit indices in February, and GFI launched a platform for trading indices and CDS in August. Creditex’s platform has been a success thus far. Electronic trading brings greater transparency, leading to narrower bid-offer spreads and cheaper trading costs. Most trades are still voice-brokered, but several brokers already have electronic platforms or are developing them. Despite the obvious attractions of electronic trading, the market will remain a hybrid one. Banks are keen to direct the largest deals to traders to process so as to avoid any colossal mistakes; voice brokers can sometimes more easily put a deal in the market bit by bit to hide its overall size and avoid moving the price adversely.
The next major development to hit the market will be the spread of electronic trading, hence creating the need for automated pricing engines. For any high-volume market to be active, its large dealers need to have automated pricing engines that send out bid-ask offers and respond to inquiries in real time. Once there is sufficient client demand in any market, dealers build the engines and links to existing platforms. These engines are fairly standard in the foreign exchange, global government bond, agency, and mortgage markets, as well as for liquid corporate bonds, on which most CDS are based. Banks are starting to contemplate enhancing engines for corporate bonds, and when they do the market will become far more actively traded than it already is.
All the pieces are in place for robust growth in the years to come. How much room does the market have to grow? A managing director at Deutsche Bank, one of the largest dealers in the market, said only about 30—40 percent of all potential users are using index products. He also expects substantial growth in use from clients that already trade the product.
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