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Credit derivatives market expands: Fitch


September 9, 2004   by Canadian Underwriter


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The global credit derivatives market (CDx) was up to US$2.8 billion of gross sold outstanding (US$3 trillion including cash collateralized debt obligations), up 71% over 2002, according to the latest study by Fitch Ratings. The rater notes that single-name credit default swaps grew 100% to US$1.9 trillion in 2003, while portfolio products (including traded indices) were up 49% to US$754 billion. But this growth was little influenced by insurers’ participation in the market.
Global insurers’ exposure to the CDx as protection sellers increased, but this is largely based on the participation of one player overall, insurance company exposure to CDs fell 56% in North America and 21% in Europe.
On the other hand, banks moved into the role of “seller” from the more traditional role of “buyer” in the Cdx. “Many of the larger banks and broker dealers have moved from net protection buyers to net protection sellers, coinciding with an increased willingness among CDx dealers to inventory large ‘correlation books’ of credit risk,” notes Roger Merritt, managing director at Fitch. “The market’s explosive growth is being propelled in large measure by inter-dealer trading rather than risk transference motivations on the part of banks.”
Trading was the most common motivation for using CDs cited by global banks, with just 19% citing credit risk as the motivation.
For example, one-half of European banks acted as protection sellers. “Protection selling via CDx is a preferable alternative for sourcing credit and generating more attractive returns than those available in their domestic markets,” explains Ian Linnell, another managing director for Fitch. However, he adds, “there is a need among banks to develop improved financial disclosure of CDx usage to allow for the adjustment of traditional credit measures to incorporate this alternative form of risk taking.”
Overall, ratings quality in the market declined, with growth in below-investment grade and unrated exposures, as the market expanded for lower rated names.


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