Lifting the veil: New data on credit default swaps
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For people who can’t get enough of huge numbers: The derivative-securities industry has begun providing a weekly tally of outstanding credit default swaps, in a move to try to defuse concerns about the risks the instruments pose to the financial system.
There now are $33.6 trillion in swap contracts outstanding on government debt, corporate bonds and asset-backed securities worldwide, the Depository Trust & Clearing Corp. said in the first weekly report on its website. That’s actually less than the $50-trillion-to-$60-trillion numbers that often have been bandied about.
Credit default swaps are, in effect, insurance contracts that allow investors to protect against the risk of default on a government or corporate issuer’s debt. Swaps also can be used to speculate on a default.
Because the contracts are private agreements between investors and don’t trade on an exchange, data on the size and scope of the swaps market haven’t been readily available, even as the business has mushroomed in recent years.
The fear has been that a major corporate failure could bankrupt untold numbers of swap sellers.
That issue came to a head after brokerage Lehman Bros. Holdings Inc. failed in mid-September, and some analysts worried that investors who sold insurance on Lehman debt could owe tens of billions of dollars in payments to insurance buyers.
However, the net amount of money changing hands between Lehman swap sellers and buyers totaled $5.2 billion at the final settlement of the trades, according to DTCC. It was the first time the group had released such information from its data warehouse.
Likewise, the overall total of $33.6 trillion in gross outstanding swap contracts overstates what is at risk because it includes offsetting trades among swap investors.
The gross total of swaps outstanding on Brazil‘s government debt, for example, is $147 billion. But the ‘net notional’ swap amount on the country’s debt is $12.2 billion, after canceling out overlapping trades, DTCC said.
Even those net amounts can be misleading. They represent the maximum amount that sellers could owe buyers, without taking into account the recovery rate on defaulted debt (which could be substantial, thereby reducing what sellers would owe).
From Bloomberg News:
After canceling out overlapping trades, Italy’s government debt tops the list [of net notional swaps] with $22.7 billion in contracts, according to DTCC data. A net amount of $16.6 billion of contracts are outstanding on Spain; $12.4 billion on Deutsche Bank, Germany’s largest bank; and $12.1 billion on General Electric Co.’s finance arm, GE Capital Corp.
DTCC, which is owned by major brokerages and other financial firms, provides clearing, settlement and information services for securities trades.
The securities industry has faced calls for federal regulation of the swaps business. By releasing more data on the business, the industry is trying to damp fears that swaps are a time bomb waiting to explode.
‘Publishing this data will provide greater transparency in a critical market,’ said Tim Ryan, the head of the Securities Industry and Financial Markets Assn., in a statement. ‘This is an important initiative upon which the industry will continue to build.’