Credit Derivatives in 2009 & Current Developments
d-fine – Risk Management Breakfast – Tower 42
London, 25 September 2009
Tim Brunne Credit Strategist
2
Introductory Remarks
During the crisis, credit derivatives "enjoyed" particular attention by politicians, regulators and the media (as well as securitizations and structured credits).
Regulation, processing, standardization and central clearing of OTC derivative markets have been debated for years.
CDS sometimes became a sort of scapegoat for the financial market crisis (Buffet, Soros, Dinallo, Petersen, etc.). But not the instruments failed, investment strategies did.
“Naked” CDS long; opaque market; central counterparty clearing
The demise of Bear Stearns, Lehman Brothers and, last but not least, the bailout of AIG (Financial Products) put the industry under intense pressure to improve the resilience of the market with respect to counterparty risks.
Some not-so-constructive proposals are not yet entirely off the table, but much has changed during the past 11 months
"Financial regulatory overhaul", "Resilience of OTC derivatives market", ISDA, ICE
3
AGENDA
GLOBAL OTC DERIVATIVES
VERY SHORT COURSE ON CDS
CORPORATE AND SOVEREIGN CDS
TRADING CREDITS DURING THE CRISIS
CDS CENTRAL COUNTERPARTIES
4
From more than 100% annual growth to a 50% decline
Source: ISDA, UniCredit Research
CDS outstanding volumes (ISDA semi-annual primary member survey)
0
10
20
30
40
50
60
70
Jun 01 Jun 02 Jun 03 Jun 04 Jun 05 Jun 06 Jun 07 Jun 08 Jun 09survey effective-date
tota
l CD
S o
utst
andi
ngs
(US
D tn
eq.
) ISDA primary member survey
5
Shrinking global CDS volumes indicate change in 1H08
Source: BIS, UniCredit Research
CDS outstanding volumes (BIS semi-annual G10 survey data)
0
10
20
30
40
50
60
Dec 04 Jun 05 Dec 05 Jun 06 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08
notio
nal a
mou
nt o
utst
andi
ng (U
SD
tn e
q.)
Multi-name instruments
Single-name instruments
6
Gross market value surges to USD 5.7tn at YE 2008
Source: BIS, UniCredit Research
Global CDS gross market values (BIS semi-annual survey data)
0
1
2
3
4
5
6
Dec 04 Jun 05 Dec 05 Jun 06 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08
gros
s m
arke
t val
ue (U
SD
tn e
q.) Multi-name instruments
Single-name instruments
7
CDS gross market value grows at fastest pace
Source: BIS, UniCredit Research
Global OTC derivatives gross market values (BIS semi-annual survey data)
0
1
2
3
4
5
6
Dec 04 Jun 05 Dec 05 Jun 06 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08
gros
s m
arke
t val
ue (U
SD
tn)
0
4
8
12
16
20
24
gros
s m
arke
t val
ue (U
SD
tn) (
IR)Credit default swaps
FX contracts
Interest rate contracts (right scale)
8
DTCC covers about 80% of the market
Source: ISDA, DTCC, UniCredit Research
ISDA semi-annual primary member survey compared to DTCC TIW data
0
10
20
30
40
50
60
2007-12-28 2008-05-23 2008-10-17 2009-03-13 2009-08-07 2010-01-01end-of-week date
tota
l CD
S no
tiona
l (U
SD tn
eq.
)
0
10
20
30
40
50
60total CDS outstandings (ISDA)
total gross notional (DTCC; CDS,indices & index tranches)
9
AGENDA
GLOBAL OTC DERIVATIVES
VERY SHORT COURSE ON CDS
CORPORATE AND SOVEREIGN CDS
TRADING CREDITS DURING THE CRISIS
CDS CENTRAL COUNTERPARTIES
10
Premium Leg
Default LegEffective Date Maturity Date
Premium Payments
Single-name CDS – The most simple contract
(A) No default event
(B) Default event
Premium Leg
Default LegEffective Date Maturity Date
Default Payment(1 – Recovery)
Accrued Premiumat Default
11
Index CDS – The cornerstone of CDS liquidity
Example with two default events
Reference notional
Effective date Maturity date
Reference notional will be reduced by 1/125
Default payment(1 – Recovery)/125
Reduced premium payments
Effective date Maturity date
Premium leg
Default leg
12
Credit derivatives referencing corporate and sovereign credit risk
Risk type
Credit Default Swaps (CDS)Digital Default Swaps (DDS)Forward CDSConstant Maturity CDS
Linear Spread
Risk
Single-name Portfolio
CDS Indices (iTraxx, …), FuturesBespoke Linear BasketsDynamic Leverage Note (e.g. CPDO)CPPI Structures
DefaultCorrel.
First-to-Default (FTD) BasketsIndex Tranches (iTraxx, CDX)(Bespoke) Coll. Debt Obl. (CDO)CDO^2Equity Tranches, POETs, Tranchelets
Credit Default SwaptionsSpreadVolatility
CD Swaptions, Variance SwapsOptions on Futures / TR Locks
Hybrid Capital (Financials/Non-Fin.)Sub CDS, Equity Default SwapsCapital Structure Arbitrage
HybridRisk
First-to-Trigger Baskets on EDSCollateralized Fund Obligations (CFO)
13
AGENDA
GLOBAL OTC DERIVATIVES
VERY SHORT COURSE ON CDS
CORPORATE AND SOVEREIGN CDS
TRADING CREDITS DURING THE CRISIS
CDS CENTRAL COUNTERPARTIES
14
Outstanding CDS volumes continue to shrink in 2009
Source: DTCC, UniCredit Research
Aggregated CDS gross volume (DTCC trade information warehouse, weekly data)
0
5
10
15
20
25
30
35
2008-10-31 2009-01-16 2009-04-03 2009-06-19 2009-09-04end-of-week date
CD
S g
ross
vol
ume
(US
D tn
eq.
) Index CDS Single-name CDS Index tranches
15
Dealer vs. customer – Who buys CDS?
Source: DTCC, UniCredit Research; effective date: 18 September 2009
Global CDS breakdown by CDS type, CDS buyer and seller (DTCC)
1.301
1.403
0.1041.1901.240
0.135
65%
70%
75%
80%
85%
90%
95%
100%
Index (8.4 USD tn) Single (15.6 USD tn) Tranche (3.1 USD tn)CDS type (total gross volume)
(per
c.) t
otal
gro
ss n
otio
nal (
US
D tn
)
Customer(protection buyer) - Customer(investor)
Dealer(protection buyer) - Customer(investor)
Customer(protection buyer) - Dealer(investor)
Dealer(protection buyer) - Dealer(investor)
16
Investment-grade CDS indices are most liquidly traded
Source: DTCC, UniCredit Research; effective date: 11 September 2009
Gross notional: Break-down by index/index tranche family
00.5
11.5
22.5
33.5
44.5
5
iTraxx E
urope
Main
iTraxx E
urope
Fin
iTraxx E
urope
HiVol
iTraxx E
urope
XO
iTraxx E
urope
othe
rCDX.N
A.IG
CDX.NA.IG
.HVOL
CDX.NA.H
Y
CDX.NA ot
her
CDX.EM indic
esLC
DX.NA
iTraxx L
evX
ABX/CMBX/TABXiTrax
x othe
r
other
CDS indic
esgros
s no
tiona
l vol
ume
(US
D tn
eq.
)
tranche volume (est.) (weekending 11-Sep-09)
index volume (est.) (weekending 11-Sep-09)
17
Index-CDS standardization facilitates trade compression
Source: DTCC, UniCredit Research
Aggregated index CDS gross volume (DTCC TIW, weekly data)
7
8
9
10
11
12
13
14
15
2008-10-31 2009-01-02 2009-03-06 2009-05-08 2009-07-10 2009-09-11end-of-week date
gros
s no
tiona
l vol
ume
(US
D tn
eq.
)
90
110
130
150
170
190
210
230
num
ber o
f con
tract
s (th
sd)
gross notional (index CDS) (LS) number of contracts (RS)
18
The fingerprints of index-portfolio compression trades
Source: DTCC, UniCredit Research; *DTCC only releases data for a particular index series if a minimum activity level is reached within the respective week.
New-trade volumes of iTraxx Europe Main, index & tranched-index (not complete*)
0
50
100
150
200
250
300
350
400
2009-01-02 2009-03-06 2009-05-08 2009-07-10 2009-09-11end-of-week date
iTra
xx M
ain
new
trad
es (i
nd./t
r.) (E
UR
bn)
S 1S 2S 3S 4S 5S 6S 7S 8S 9S 10S 11
19
During the crisis sovereign and financial CDS gained in importance
Single-name corporate and sovereign CDS: breakdown by sector and CDS seller
Source: DTCC, UniCredit Research; effective date: 18 September 2009
0
1
2
3
4
Financ
ials
Indus
trials
Techn
ology
& Tele
com
Consu
mer Goo
ds
Consu
mer Serv
ices
Health
Care
Basic
Materia
lsOil &
Gas
Utilitie
s
Other c
orpora
te CDS
Sovere
igns &
Stat
es
CMBSRMBS
Loan
CDS
Other C
DS
gros
s vo
lum
e (U
SD
tn e
q.) Customer (week ending 18-Sep-2009)
Dealer (week ending 18-Sep-2009)
20
iBoxx € Corporates credit risk – Cash outweighs CDS
Source: Markit, DTCC, UniCredit Research; effective date 24 July 2009; CDS volumes for iBoxx-DTCC entities and single-name CDS only; iBoxx-DTCC entities are iBoxx € issuers which are also listed among the most important single-name CDS reference entities by the DTCC TIW
0
50
100
150
200
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB-
bond
not
iona
l am
ount
(EU
R b
n)iBoxx € Financials iBoxx € Non-Financials
0
10
20
30
40
50
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB-
CD
S n
et n
otio
nal
(EU
R b
n)
iBoxx € Financials iBoxx € Non-Financials
21
AGENDA
GLOBAL OTC DERIVATIVES
VERY SHORT COURSE ON CDS
CORPORATE AND SOVEREIGN CDS
TRADING CREDITS DURING THE CRISIS
CDS CENTRAL COUNTERPARTIES
22
CDS market only became illiquid in 4Q08
iTraxx Europe index skew (index fair value vs. traded spread)
0
50
100
150
200
250
300
Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09
CD
S s
prea
d (b
p)Fair Value iTraxx Main 5Y
25
Are single-name CDS for trading or hedging?
Aggregate single-name contract volume by maturity
Source: DTCC, UniCredit Research
0
0.5
1
1.5
2
2.5
3
3.5
2009 2014 2019 2024 2029 2034year of scheduled maturity
gros
s no
tiona
l vol
ume
(US
D tn
eq.
)
0
10
20
30
40
50
60
70
Avg
. not
iona
l (U
SD
mn
eq.)
Gross notional (LS) (week ending 18-Sep-2009)
Mean contract size (RS)
26
Single-name CDS market activity: Staying liquid vs. cash-hedging
-100
-80
-60
-40
-20
0
20
40
60
80
100
2009 2010 2011 2012 2013 2014CDS maturity
wee
kly
gros
s no
tiona
l cha
nge
(US
D b
n)
2009-01-09 2009-01-162009-01-23 2009-01-302009-02-06 2009-02-132009-02-20 2009-02-272009-03-06 2009-03-132009-03-20 2009-04-032009-04-10
Aggregate weekly single-name gross vol. changes by year of scheduled termination
Source: DTCC, UniCredit Research.
27
Single-name CDS market activity: 5-year is king
-250
-200
-150
-100
-50
0
50
100
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019CDS maturity
wee
kly
gros
s no
tiona
l cha
nge
(US
D b
n)
2009-01-09 2009-01-16
2009-01-23 2009-01-30
2009-02-06 2009-02-13
2009-02-20 2009-02-27
2009-03-06 2009-03-13
2009-03-20 2009-04-03
2009-04-10
Aggregate weekly single-name gross vol. changes by year of scheduled termination
Source: DTCC, UniCredit Research.
30
AGENDA
GLOBAL OTC DERIVATIVES
VERY SHORT COURSE ON CDS
CORPORATE AND SOVEREIGN CDS
TRADING CREDITS DURING THE CRISIS
CDS CENTRAL COUNTERPARTIES
31
CDS central counterparty – A simple notion that bears subtleties
A clearinghouse acts as the buyer to every seller and seller to every buyer, reducing the risk of a counterparty defaulting on a transaction. It also provides one location for regulators to gain insight into traders’ positions (and possibly their prices).Assuming the existence of 2 CCPs and around 20 major dealers, the number of bilateral relationships is reduced from 190 to 40 by using the CCP CDS settlement model.The schematic view depicted above hides the complexities that are associated with switching from one regime to the other: Credit event settlement, efficient and prudent margining/risk management, trading model.
Major CDS DealerMajor CDS DealerCentral Counterpart Major CDS DealerCentral Counterpart Major CDS Dealer
Purely bilateral trading and settlement Central counterparty clearing of CDS
CDS central counterparty
32
ICE Trust US cleared USD 2.1tn CDS to date
Source: ICE Trust US, ICE Clear Europe, UniCredit Research
0
60
120
180
240
300
2009-03-27 2009-05-01 2009-06-05 2009-07-10 2009-08-14 2009-09-18
wkl
y gr
oss
notio
nal
(US
D b
n)
0
0.6
1.2
1.8
2.4
3
wkl
y co
ntra
cts
(thsd
)Cleared CDX.NA CDS (USD bn)Number of cleared CDX contracts (RS)
0
40
80
120
160
200
2009-03-27 2009-05-01 2009-06-05 2009-07-10 2009-08-14 2009-09-18
wkl
y gr
oss
notio
nal
(EU
R b
n)
0
0.6
1.2
1.8
2.4
3
wkl
y co
ntra
cts
(thsd
)Cleared iTraxx Europe CDS (EUR bn)Number of cleared iTraxx contracts (RS)
33
On-the-run iTraxx Europe avg weekly turnover exceeds EUR 40bn
Weekly turnover in the most liquid euro-denominated CDS: iTraxx Europe S11
Source: DTCC, UniCredit Research
-160
-120
-80
-40
0
40
80
2009-03-27 2009-05-01 2009-06-05 2009-07-10 2009-08-14 2009-09-18end-of-week date
CD
S-n
otio
nal w
kly
turn
over
(EU
R b
n)
iTraxx Europe S11 (new trades)
iTraxx Europe S11 (trade terminations)
34
On-the-run iTraxx Europe avg weekly clearing volume is EUR 20bn
-160
-120
-80
-40
0
40
80
2009-03-20 2009-04-24 2009-05-29 2009-07-03 2009-08-07 2009-09-11end-of-week date
wkl
y vo
lum
e of
cle
ared
CD
S (E
UR
bn)
iTraxx Europe S11 (ICE-cleared volume)
Cleared volume of untranched iTraxx Europe Main Series 11 (ICE Clear Europe)
Source: ICE Trust US, ICE Clear Europe, UniCredit Research
35
"G15" committed to clearing 80% of historic "eligible" CDS by Oct.
Source: DTCC, ICE Trust US, ICE Clear Europe, UniCredit Research; effective date is 18 September 2009
0 200 400 600 800 1000 1200 1400 1600 1800 2000 2200 2400 2600 2800
CDX.NA.IG
CDX.NA.IG.HVOL
CDX.NA.HY
iTraxx Europe
iTraxx Europe HiVol
iTraxx Europe Crossover
cumulative cleared CDS notional (USD bn)
S8 S9 S10 S11 S12
0 200 400 600 800 1000 1200 1400 1600 1800 2000 2200 2400 2600 2800
CDX.NA.IG
CDX.NA.IG.HVOL
CDX.NA.HY
iTraxx Europe
iTraxx Europe HiVol
iTraxx Europe Crossover
DTCC total gross CDS volume (USD bn)
S8 S9 S10 S11 S12
36
How many single-name CDS will be offered by CCPs?
0%
20%
40%
60%
80%
100%
0 250 500 750 1000 1250no. of ref. names / underlying indices (sorted by gross notional)
gros
s no
tiona
l (%
of t
otal
vol
ume)
0
3
6
9
12
15
18
21
24
27
gros
s no
tiona
l (U
SD
tn e
quiv
.)
cumulative volume (single-name, CDX.NA and iTraxx CDS)
Source: DTCC, UniCredit Research; effective date 3 April 2009
CDS central clearing
Top-500 CDS references (indices, single-names) represent ~80% of gross volume
37
Buy-side access to central clearing will be launched in October 09
Non-dealers get access to ICE via account seggregation, separating the customers' margin payments and positions from those of their dealers.Who is eligible to become an ordinary clearing member?How many clearing houses will emerge for CDS?Will regulators sanction bilateral trades among non-dealers?
Source: ECB, UniCredit Research
38
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Dr. Tim BrunneSenior Credit StrategistCredit Strategy & Structured Credit ResearchUniCredit ResearchTel. +49 89 378 13521 – Fax +49 89 378 33 [email protected]
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