CDS, credit models and the repo spike

Two weeks on, December 22, 2018 – January 4, 2019

7 days montage 050118

Isda seeks consensus on CDS clean-up

Credit definitions amendments expected in Q1 to stamp out manipulated triggers

Pooled resources offer way to keep credit models afloat

Supervisors drive banks to seek more corporate default data and cost-effective model improvements

Repo rate hits 7.25% on year-end volatility

US Treasury issuance on December 31 said to have fuelled last-minute dash for cash



With an end-2018 goal now firmly in the rear-view mirror, an Isda-led working group continues to wrestle with the problem of manipulated defaults. Several cases in the past five years have involved credit default swap holders colluding with the issuers of the underlying debt to trigger specific CDSs without actually undergoing a general default on debt. The CDS holder gets the payout, the debt issuer gets its share – in the form of access to new funding from the CDS holder – and the CDS issuer loses out.

If you follow the commonly used “CDSs are insurance” approach, this looks like fraud. And lawyers haven’t been shy about making the comparison, likening manipulated defaults (or “narrowly-tailored credit events” as they are more tactfully known) to a property insurer facing “the risk that the beneficiary will set fire to his own house”. The US Commodity Futures Trading Commission takes – or at least took – a similar position.

So far, none of these defaults have made it very far in the criminal courts; a New York district court kicked the issue back to Isda in January 2018, but the credit determinations committee can’t consider the motivation behind a default, only the mechanics of whether a default has occurred. As such, it’s very wary indeed of taking on a role that would force its members to make judgements about conspiracy, mens rea, and other concepts more at home in criminal law. CDS market participants are also worried about introducing more uncertainty into the credit determination process.

And Isda worries, too, about whether the task it has set itself is even practically possible. Can CDS documentation be amended to prevent manipulated defaults, without creating new loopholes or damaging the CDS market more widely - and in a form that gets generally accepted to avoid fragmenting and balkanising the credit derivatives market?

One of the best arguments in Isda’s favour is, ironically, one made last year by opponents of reform: that the number of manipulated-default cases remains very low. With only a handful of events in the last five years, and the two most egregious both involving the same funder/CDS holder (Blackstone Group’s GSO), this is a problem Isda can afford not to solve completely. Any documentation change making manipulated default noticeably more difficult, or even just a disapproving hard stare from the CFTC in the direction of Blackstone, would reduce the problem to a de minimis level.

Over-reaching, on the other hand, risks damaging more of the CDS market. If manipulated defaults become more common, the calculus will change. At present it isn’t a market-threatening problem.



Traded debt instrument position risk made up 60% of EU dealers’ total standardised approach market risk-weighted assets. Foreign exchange risk accounted for 19%, equities position risk 17% and commodities 4% in the first half of 2018.



“If you are asking if we’ve seen a sizeable move towards [the Tokyo Overnight Average Rate] already, the answer is no, I do not think so, because we are still discussing how best to utilise the rate across various financial products” –Taro Matsuura, Mitsubishi UFJ

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