Facing Off Against the Credit Derivatives Cabal

[Sbelmont]

Facing Off Against the Credit Derivatives Cabal

Credit derivatives are all the rage these days. You hear about them just about every day. However, I never knew that it was a $27 trillion market, or how hard it is to break into it?

When a small cabal of firms controls 90% of such an enormous market, then perhaps something needs to be done. They are so powerful that even massive exchanges like Eurex are powerless against them.

 

[empee]

i haven't read it, but your talking nominal value I assume. I don't think its as big, (but not small either) that ppl are concerned about. Plus how much if it is hedged. When then begs the question, who is/are the counterparties/what is the risk of that.

At some point you know its going to end badly.

 

[Bernoulli]

The article was posted 3 days after the Eurex credit derivative future was available. I don't know what you can project from the first three days of trading for anything.

The 20+ billion figure is notional value. I would think that for this market to end badly that credit markets in general would have to end badly, which isn't likely to happen. That doesn't mean some hedge fund or Orange County treasurer won't load up on dicey credits but that's not the fault of a legitimate risk transfer tool.

Here is a background article on the market (http://www.securitization.net/pdf/Publications/CreditDerivative_Mar07.pdf). It points out that after languishing for years exchange traded swap futures are now taking off -- after some members of the "cabal" became market makers -- and suggests this may be a model for credit futures.

 

[Sbelmont]

I think you can draw a few interesting preliminary conclusions from the Eurex product, particularly because they went out of their way to mimic the index credit swaps available in the OTC market.

However, even though they went that extra mile, and even though they've been working on these products since 2005, they still couldn't attract any significant industry participation at launch. Do you really think that will change in a few weeks or months? What incentive do the "cabal" market making firms have to abandon OTC and trade these new products?

Even more troubling, what do Eurex's troubles mean for the credit derivatives that are coming down the pike from the CME and CBOE? It certainly doesn't bode well, especially given the fact that the CME/CBOE products are very different from the OTC swaps.

 

[Mvic]

Its not just the size and rate of growth that is daunting but the lack of deoth of recent big players and the levergae employed. This was covered in detail about a month an a half ago, search my posts.

 

[Sbelmont]

That's pretty much what the article says as well.

I perused through your posts, very interesting. But now everything has changed because we finally have some hard data from the Eurex launch.

What's your opinion on this pending explosion of exchange-traded credit derivatives? Do you think they have a chance in hell or are the problems Eurex is experiencing indicative of the future?

 

[JamesVU2000]

The CDS market is a total travesty and at odds with anything the US should want in long run. A 20 trillion dollar market that is run by a small number of firms with very little oversight and almost no transprancey is awful.

 

[Sbelmont]

Quote from JamesVU2000:

The CDS market is a total travesty and at odds with anything the US should want in long run. A 20 trillion dollar market that is run by a small number of firms with very little oversight and almost no transprancey is awful.

I think that's the point of the piece. It's somewhat alarming to have such an enormous market that is dominated by a handful of trading firms. Talk about market power!!

In this oligopoly environment, how can any competing product survive? What chance do Eurex, CME or the CBOE have against this cabal? Why would any sane firm give up on a market that they control and instead transfer their business to a competing exchange-traded product? You'd have to be nuts!!

 

[archon]

I don't know. Is it really that dangerous when 70% of the OTC market consists of single name credit default swaps? The author points that out in his article as well, and I'm inclined to agree.

 

[Sbelmont]

It definitely can be a problem, especially if that other 30% consists of extremely complicated and highly leveraged positions.

Didn't Deloitte just come out with a study that says most financial firms don't understand the risks of their derivatives positions? If that's the case, then the credit derivatives explosion could pose a significant risk to the market as a whole.