Credit default swaps (CDS) act as insurance contracts against company defaults. Now, markets for CDS are in turmoil as banks face troubling prospects around the world. The heavy involvement of CDS has some regulators calling for more oversight of these opaque contracts. Martin Arnold and Laurence Fletcher report for the Financial Times:
The European Central Bank’s top supervisor has claimed “opaque” trading in credit default swaps is harming banks’ share prices and could threaten a run on deposits.
Andrea Enria, chair of the ECB supervisory board, called for a review of the market after sharp moves in the prices of CDS preceded a sudden drop in the shares of Deutsche Bank and other European lenders last Friday.
“With a few million you can move the CDS spread of a trillion-euro-asset bank and contaminate of course stock prices and possibly also deposit outflows,” Enria told a conference in Frankfurt. “So that is something that concerned me a lot.”
The turmoil in the banking sector has thrown the spotlight on to the market for single-name CDS, which act like insurance and pay out if a company defaults, making them closely watched as an indicator of a company’s financial strength.
Answering a question about Friday’s share price fall at Deutsche, Enria said the CDS market was “very opaque, very shallow and very illiquid”. He said there should be “more transparency” in the CDS market by shifting trading to central counterparty clearing and it should be examined by the Financial Stability Board, a global regulatory body.
“For instance, having these types of markets all centrally cleared, rather than having all these . . . opaque transactions going on somewhere, where you don’t know who is trading, I think that would already be great progress in this market,” he said.
Deutsche shares fell as much as 14 per cent on Friday, prompting German chancellor Olaf Scholz to reject comparisons between the country’s biggest bank and Credit Suisse, which was forced into the arms of its rival UBS in a weekend rescue deal. Shares in Deutsche have since partially recovered, but remain down a fifth in the past month.
The derivatives are thinly traded — in the final three months of last year there were on average only nine trades per day in Deutsche’s CDS even though it is one of the most traded, according to the US’s Depository Trust and Clearing Corporation, which runs a swaps data repository, although it is unclear how often they were traded this month.
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