Decryption of derivatives – Q2 2021 | Kramer Levin Naftalis & Frankel LLP

DC transparency, really?

The process of determining credit derivatives has, for some time, been obscured by a relative mystery. As credit default swap (CDS) strategies have become more complex and gray area issues have become more common, advocacy before the Determination Committee (DC) has also intensified. In most cases, determination requests and other documents and the arguments submitted to the DC were made available through the DC website. Recently, however, the DC appears to have ceased its practice of publishing even simple determination requests in their entirety, in favor of simply summarizing the requests and / or views of market participants on specific issues. The ultimate goal may well be to limit the number of (competing) bids from market participants on the same issue or request. After all, market participants may have less incentive to submit their own views on a specific issue if they don’t see a pitch that they may disagree with. However, this approach leaves open the question of if the DC provides full context for market participants. At the very least, DC doesn’t seem to have gone so far as to ban requests for a specific outcome, but DC is one step further. Additionally, while the CD appears to be striving to reduce the level of advocacy it receives, a lack of transparency could well lead to more market participants submit bids to make sure their views are taken into account. Ultimately, it will be difficult to control the behavior of market participants who are likely to win or lose big on their trades. From our side, we would be in favor of increased transparency of submissions from market participants, perhaps not live, but at least once the DC has made a final decision on a specific request.


Kramer Levin’s lead voice on CDS

In keeping with our position as a thought leader in the CDS market, we have partnered with LexisNexis to create its CDS * content.


The corporate bond market embraces remote working

In 2020, many people moved to work outside the office; in 2021, investors in corporate bonds can now gain exposure to corporate bonds without entering the bond market. Cboe began offering bond index futures, allowing market participants to gain synthetic exposure to US corporate bonds. Futures contracts on the Cboe index, at least in substance, offer a competitor product to index CDS. While the $ 8.8 trillion The US corporate bond market offers a sizeable pie for competing products, the introduction of index futures adds a competitor to a previously monopolized space. Initial negotiation in the high yield index term was around $ 200 million, with around $ 100 million in quality investment, and it remains to be seen what open interest this product will attract.


Decathlon LIBOR: CDS rushes towards the transition

CDS LCH and ICE clearing houses moved to post-LIBOR risk-free rates in the second quarter. Until transition, LCH and ICE used federal funds and EONIA for valuation purposes for cleared CDS. Now, authorized CDS models adopt SOFR to valuation and margin purposes, with the accounts of market participants being adjusted for the impact of the transition. This $ 2.3 trillion The product transition is another boon for the LIBOR transition.


Mapping CDS in the EU

A recent European Systemic Risk Council document examines the relationship between cross-border holdings of credit derivatives and cross-border investment links in the European Union. The study shows that larger amounts of credit derivatives are bought and sold to residents of financial partner countries. It shows that when banking systems are net buyers, they buy more net protection on countries to which they have on average larger portfolio debt exposures (which in turn reduces bilateral credit exposures). Conversely, when banking systems are net sellers, they tend to sell larger amounts of protection on countries where they hold larger debt portfolios (thereby increasing their exposures).


*This excerpt from Practical Guidance®, a comprehensive practical guidance resource providing information from leading practitioners, is reproduced with permission from LexisNexis. Reproduction of this material in any form is expressly prohibited without the written consent of LexisNexis.

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