Uncleared, unrated CDS notionals boomed in H1 2022

Non-cleared trades up 21% in six months and 14% in twelve, BIS data shows

Uncleared, unrated over-the-counter credit default swaps (CDSs) boomed during 2022’s turbulent first half, with notional value returning to levels unseen in four years, data from the Bank for International Settlements (BIS) shows.

Some $754.4 billion of CDS notional as of end-June referenced debt with no credit rating and was not routed through central counterparties (CCPs), up 21% in six months and 14% in 12, and the most since the first half of 2018.



In contrast, notionals for the same type of instruments vis à vis CCPs plummeted 9% over the first half and just under 1% compared with June 2021, to $1.26 trillion. This equated to a 63% clearing rate, the lowest since end-2019.

The increase for bilaterally-settled CDSs was overwhelmingly driven by trades with fellow BIS-reporting dealers, for 35% of the change in the first half and 49% year on year. Trades vis à vis banks and securities firms contributed the second most, 21% and 18% of the increase over the respective periods.



Notionals for contracts where the counterparty was an insurance or financial guaranty firm rose 71% compared with end-2021, the most percentage-wise across all counterparties. Non-financial customers – which include corporations, governments and households – recorded the largest surge year-on-year, at 55%. However, at $38.7 billion and $43 billion respectively, the two counterparty classes made up a tiny, if growing, slice of the non-cleared cake.

Contrasting with the trend in the unrated space, CDSs referencing investment- or sub-investment-grade debt tilted towards CCPs, with clearing rates rising two percentage points to 69% for the former and one percentage point to 61% for the latter.

What is it?

The BIS OTC derivatives statistics capture the outstanding positions of banks and other major derivatives dealers at end-June and end-December each year. They are reported on a consolidated basis and combine two sources: data reported every six months by derivatives dealers in 12 jurisdictions; and data reported every three years by dealers in more than 30 additional jurisdictions.

The CDS data is broken down by the rating of the referenced exposure, as well as by eight counterparty types: other reporting dealers; CCPs; banks and securities firms; insurance and financial guaranty firms; special purpose vehicles and similar such entities; hedge funds; other financial institutions; and non-financial customers.

Why it matters

That banks – whether broker-dealers themselves or not – dived into unrated CDSs during 2022’s stormy first half is no surprise. In just six months, default risk surged across the board as it hadn’t since the Covid-19 pandemic’s early days, while thinning market liquidity fanned worries about being able to unload souring exposures at acceptable prices.

By buying unrated CDSs, lenders may have sought to hedge hard-to-value, hard-to-shed exposures, such as loans in the middle market or non-syndicated spaces – a hot potato in need of some cooling. On the other side of the trade, hedge funds and other institutional investors may have seen chances for opportunistic trades as volatility revealed who had been swimming naked during the cheap-money era.

That this didn’t lead to a surge in clearing rates both suggests that counterparty risk wasn’t as growing a concern as credit risk and that demand accrued mostly to instruments that weren’t clearable in the first place.

Whether dealers continued to write unrated, uncleared CDSs into the second half of the year – data for which won’t be available from the BIS until May – was likely predicated on two factors: whether capital charges for counterparty credit risk, starting with credit valuation adjustments, remained within capacity; and whether the extra notionals did not threaten to inflate systemic scores to costlier levels.

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