The next stage for CDS

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Nick Sawyer
01 Apr 2004

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Risk management

Credit derivatives indexes have come a long way since they first emerged in the region a little over a year ago. The latest development is the listing of these products on exchanges, with the Singapore Exchange the first to declare its intention to list Trac-x futures.

It could mark the next stage of development for the credit derivatives market. An exchange-traded contract is likely to attract a wider range of investors, with smaller contract sizes even making the product more accessible to retail investors. In addition, the clearing, settlement and on-screen trading facilities offered by exchanges are likely to improve the transparency of credit derivatives. With Asia’s credit default swaps market still predominantly one-way, any improvement in liquidity would be a massive boon to the market.

Dow Jones Indexes, the manager of the Trac-x indexes, is already talking to a couple more exchanges in Europe and the US. By the end of the year, we could see round-the-clock trading of exchange-traded credit derivatives contracts (see pages S14–S15).

At the same time, synthetic collateralised debt obligations (CDOs) remain in strong demand from the region’s institutional investors. Given some of the credit concerns following the collapse of Parmalat at the end of last year, most of this attention is now focusing on single-tranche synthetic CDOs, meaning investors are playing more and more of an active, hands-on role in choosing their own tailor-made portfolios.

Consequently, a number of banks are now offering their customers a range of tools to help this process, from models aimed at evaluating the risk/reward characteristics of individual credits, to CDO portfolio construction and optimisation tools, to web-based systems that simulate the impact of any substitution trade on a portfolio. Increasingly, technology is becoming a key area of differentiation between banks, in what is becoming a more and more competitive environment (see pages S18–S19).