Market Share, Profitability, Why CDS Isn’t On An Exchange

Posted by on Mar 1, 2012 in Uncategorized | No Comments

So, yesterday it was revealed that both Goldman and JPM had about 145 billion of “gross” notional outstanding on CDS related to the PIIGS.  That means they each had roughly 145 billion of purchases and sales.  They spoke about various netting agreements that makes the real number lower.  They also mentioned with collateral and on a mark to market basis, the real exposure is far lower.  Fine, though I wonder why they don’t execute the “master” netting and get the gross notionals down?  Wouldn’t that help the system?  If these were cleared or on an exchange, all they would have a single net exposure for each country.  The collateral and netting would be handled at the central clearing or exchange.  Wouldn’t that be simpler?  Safer?  The e-mini S&P future contract seems to be able to trade that way just fine, and it is more volatile than CDS on most days.  Italian CDS is in 25 bps today – seems like a lot, but the up-front payment to buy or sell Italian CDS has changed by less than 1%.  The ES futures contract has had an almost 1% move already today and the actual stock market hasn’t even opened yet.

According to DTCC, these are the gross notionals outstanding for the 5 countries that were mentioned.

                                                            DTCC Gross Notional

So the total gross notional is 658 billion.  That would mean that JPM and Goldman each have about 22% of the total gross notional outstanding.  So almost half of the entire gross notional outstanding on PIIGS CDS sits on the books of 2 dealers.  Why is there no rush to get these products cleared?  It is now basically 4 years since Bear Stearns was bought with an immediate and non-cancellable guaranty of their derivative books.  Recently BofA sought to move some of their trades to a different entity within their complex list of entities – presumably to enhance the counterparty exposure for some clients.

So gross notionals are a concern, counterparty is a concern, the trading is highly concentrated, and yet what limited effort has been made to clear these products properly has totally failed so far.  There are some serious vested interests to protect.