Credit derivatives

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A credit derivative is a privately negotiated agreement that explicitly shifts credit risk from one party to the other.[1] Credit Default Swaps ("CDS") are credit risk transfer vehicles that are used increasingly to assess credit worthiness.[2]

There was approximately $54 trillion in the credit derivatives market as of October 2008.[3]

Credit default swaps (CDS) are the most common type of credit derivative. American International Group (AIG)'s collapse was thought to stem from a $441 billion exposure to credit-default swaps and other derivatives.

Credit default swaps are private contracts that insure against the default of debt issuers. CDS indexes are used as a hedging tool against a basket of CDS or bonds and are standardised while individual CDS relate to a single company and are more bespoke.[4]

Lehman Brothers' credit default swaps settlement auction was one of the most expensive payouts in the history of the market.[5]

A controversy surrounding sovereign credit default swaps - a form of protection against default by a country on its treasury debt - erupted in 2011, as Greece threatened to default on its debt securities. The controversy involves the question of exactly what constitutes a "credit event". European Union policymakers have suggested a voluntary restructuring, or "reprofiling" of Greek debt would not constitute a credit event. Holders of such CDS, would not be entitled to a claim, even though debtholders would not be receiving the full present value of the debt.[6]

References

  1. Credit Derivatives. ISDA.
  2. Five Things Everyone Should Know About Credit Default Swaps. BNET.
  3. ICE Joins Banks For Global Clearing Solution. Financial Times.
  4. EU eyes clearing credit derivatives by mid 2009. Reuters.
  5. FACTBOX-Lehman CDS Settlement Auction Timeline. Reuters.
  6. Greek debt talks cast doubt over sovereign CDS. Financial Times.
Last modified on 2 January 2014, at 17:00