“Shocked, shocked”

A paper on the CDS market released yesterday by the New York Fed drew some interesting reactions in the media.  With apologies to Claude Rains and Casablanca’s scriptwriters, some news outlets are “shocked, shocked” to find that most single-name CDS are thinly traded, and that CDS exposures are often not immediately hedged. We at ISDA are not, of course, as we did similar research some time ago. It’s one of the reasons most market participants have always believed that CDS prices and price movements are one – but only one – tool that indicates the level of and changes in credit risk.

Our research also informs our view regarding post-trade reporting requirements for OTC derivatives. Most media got this right: relatively thin trading means it is harder and takes longer for dealers to hedge their risks, and post-trade reporting requirements need to be structured appropriately.

Some, though, focused on the fact that the Fed paper also said that same-day reporting requirements won’t affect same-day hedging, because most dealers don’t hedge their risk immediately. In their view, this means same-day reporting is appropriate. We (and most others) take the opposite view.  Dealers need time to hedge their positions, and inappropriate post-trade reporting for larger and less liquid transactions is likely to harm liquidity and risk management.

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