2 Mar 2012

CDS - a misconceived instrument is Null and Void

Says today's headline in a newspaper (City AM). To leave the decision about whether or not a CDS pays out in a 'credit event' to a group of market insiders at a private industry association such as ISDA makes a mockery of proper regulation in financial markets. Especially as the members of the relevant ISDA committee are the largest users and providers of credit default swaps who have made vast profits from this market during the past ten years. No surprise that the author states that "The decision has been criticised by some as making a mockery of credit default swaps on sovereign debt. These critics believe that their value has now been permanently undermined." We could not agree more and every user of this market has to face a negligence claim from his investors if he uses this product in the future. We always thought that the construction of the CDS contract was overly complicated and likely to lead to disagreement exactly at the point in time when they would be needed most, i.e. in a credit event. Would it not have been more sensible to design a product similar to an option? This could have been exercised at any time - credit event or not - simply based on the price performance of the underlying securities.

1 comment:

Rene-Pierre Azria said...

I agree. Going further, I believe that naked CDS should be outlawed, since they do not represent anything but gambling. That is, a type of gambling which does endanger the monetary systems of smaller nations and, by extension, the safety nets put in place to salvage them, at the EU and IMF levels at the moment.