Although the amount of publicly-available information has increased, the credit default swap market is still quite opaque, and regulators could use greater more data, says a new report from the International Organization of Securities Commissions (IOSCO).
The report, which doesn’t make specific policy recommendations, but seeks instead to inform the ongoing regulatory debate around credit default swaps (CDS), highlights some of the key policy issues affecting that market. It notes that the sector is undergoing rapid change, as, over the last several years, CDS contracts have become more standardized, and electronic processing and central clearing of trades have increased. The report discusses those recent changes and current trends in the CDS markets, and provides information from recent literature about the trading, pricing and clearing of CDS.
Among other things, the report also observes that the CDS market remains quite opaque. “Regulators would benefit from better access to information on trade and position data, which is necessary for financial stability supervision, for improving the assessment of counterparty risk by CCP and for the detection of market abuse,” it says.
In terms of increasing transparency for market participants, the results are more mixed. The report says that current research suggests that greater transparency may reduce information asymmetries and transaction costs, but it may also discourage dealers from providing liquidity. IOSCO says it will “continue to examine these issues in order to provide a sound basis for possible future policy proposals on how to best improve the functioning of the CDS markets.”
The report also finds that the existing research shows that “CDS have an important role in the price discovery process on credit risk and that the inception of CDS trading has a negative impact on the cost of funding for entities of lower credit quality.”
“To date, there is no conclusive evidence on whether taking short positions on credit risk through naked CDS is harmful for distressed firms or high-yield sovereign bonds,” it says, adding that IOSCO will continue to monitor market developments on this issue, too.