With three years of triple-digit growth, the market for credit default swaps has been growing like crazy, observes Brad Bailey, senior consultant for the Aite Group LLC. So it is no wonder futures exchanges are lining up to get in the game. But considering the massive investment made by dealers and institutions in OTC infrastructure, including vendor support for electronic trading, processing and
confirmation, Bailey wonders if the exchange-traded products will gain traction; especially considering that for the exchange-traded products to succeed, they will need those institutions and dealers to show bids and offers on the exchanges.
That remains to be seen; but now the CBOT and the U.S. Futures Exchange (USFE) have announced that they too will launch contracts based on credit default swaps, joining the CME, Eurex and CBOE in offering exchange-traded products based on OTC derivative contracts.
The CBOT contract will be based on the CDR Liquid 50 NAIG Index, which includes 50 North American investment-grade reference entities, developed by Credit Derivatives Research LLC. The USFE contracts, to be launched in the fourth quarter, will be the first to list the credit derivative futures on federal agency debentures, beginning with credit default swaps on the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
“Default swaps from both Fannie Mae and Freddie Mac are included in the tens of trillions of dollars referenced to the CDX family of indexes,” says Satish Nandapurkar, CEO of USFE in a statement. “Yet, there has never been a distinct government tranche to represent the highest quality credit risk.”
Robert D. Ray, CBOT senior vice president of business development, says, “CDS market participants will gain all the benefits of an exchange-traded contract, which features complete price transparency, reduction of counterparty risk, actionable pricing and a transparent, rules-based index methodology.”
Bailey expects index based credit default futures are more likely to gain traction than single names, such as those to be launched by the CBOE on General Motors Corp., Ford Motor Co., Lear Corp., Hovnanian Enterprises and Standard Pacific Corp. “I wonder how effective the single name model will be on an exchange. There are some names that are traded actively, but the exchanges will have to be in the right place at the right time, with the right product,” Bailey says, whereas the indexes are very actively traded and have very tight spreads.
And, he says, some of the formulations that the exchanges use are not entirely in line with the documentation that exists in the OTC market. For example, while the CME’s credit derivative product defines just two classes of credit events, the International Swaps and Derivatives Association (ISDA) defines eight.
