Credit due

The astonishing growth of the global credit derivatives market, which totalled $34.5 trillion in notional outstanding in 2006 according to the International Swaps and Derivatives Association, has long fuelled hope among locals that South Africa might develop a fully liquid credit derivatives market of its own. Such speculation has, so far, remained just that.

But now it seems that the Basel II revised international capital framework, due to be fully implemented in South Africa by January 2008, is one of a number of factors pushing the South African credit derivatives market forward. On pages 4-6, Clive Davidson explains how the looming full implementation of Basel II has led the country's banks to consider more sophisticated approaches to credit risk using credit portfolio management.

Securitisation, for instance, is now a staple for South Africa's major financial institutions, having been employed by them increasingly over recent years. Total annual issuance grew by 44% to R31.7 billion ($4.5 billion) in 2006, and had reached R24.3 billion by September 2007 for the year to date, according to rating agency Moody's Investors Service.

Local banks have also started to become more comfortable trading credit derivatives, with a nascent but illiquid South African credit default swap (CDS) market appearing more recently. Indeed, some banks have even begun using cutting-edge technology such as contingent CDSs to mitigate counterparty risk for clients involved in leveraged buyout deals (see pages 27-29).

Still, serious challenges remain. South Africa's domestic investors have yet to develop a real taste for high-yield debt, and the knock-on effects of the US subprime mortgage rout - both real and psychological - will not have helped. Talk of the development of a series of South African credit derivatives indexes and a continuously quoted CDS market is probably a little wide of the mark for now, say dealers. But, with full implementation of Basel II coming and the growing acceptance of new credit risk management techniques, they are closer than they've ever been.

- Mark Pengelly, Risk South Africa.