This CDS report was written by Markit’s Gavan Nolan
The size of the CDS market has been one of the most controversial - and misunderstood - issues during the current financial crisis. The oft-quoted figure of $54 trillion, sourced from an ISDA survey, has caused many an uninformed pundit to speculate that it was “out of control”. But though the ISDA survey is relatively accurate in describing gross notional outstanding, it is flawed in representing total risk.
Figures published by the DTCC, only made available in the last two weeks, give a truer picture. The table below, for week ending 7th November, shows that the total net notional outstanding - which offsets long and short positions within the same institution, thus giving a more accurate figure of risk - is only a small fraction of the total gross notional. This is because the ISDA survey counts the same position several times and doesn’t take into account aggregate risk. Gross notional in the CDS market has itself decreased significantly in recent months. This is due to compression exercises conducted by Markit and others, which allow offsetting trades to be torn up.
The latest figures show that total net notional outstanding fell by $229 billion from the previous week. Most of this was due to a $200 billion reduction in single name CDS exposure. The fact that gross single name exposure rose by $30 billion highlights the inadequacy of this metric as a risk indicator. Clearly, investors have been entering into offsetting trades to reduce their risk exposure, a fact not captured by the gross measure, which overstates exposure.
Drilling down into the single names, the DTCC data shows that the Republic of Ireland is the subject of the biggest increase in net risk exposure this week. The sovereign was the first in the eurozone to go into recession, though it has since been followed by Germany and the region a a whole. Its credit profile worsened significantly after it guaranteed its banking sector and the dire economic news has continued to flow. It looks set for a deep and prolonged period of contraction and the domestic banks will be reliant on the government guarantee for funding.
