Sovereign Credit Default Swap (BIS).pdf

BIS Quarterly Review, December 2003 79 Frank Packer +41 61 280 8449 frank.packer@bis.org Chamaree Suthiphongchai +662 283 5307 ChamareS@bot.or.th Sovereign credit default swaps1 The market for credit derivatives, or financial contracts whose payoffs are linked to changes in the credit quality of a reference asset, has expanded dramatically in recent years. According to the 2002 Credit Derivatives Report of the British Bankers’ Association, the credit derivatives market grew from $40 billion outstanding notional value in 1996 to an estimated $1.2 trillion at the end of 2001, and is expected to reach $4.8 trillion by the end of 2004.2 The same report indicates that single name credit default swaps (CDSs) accounted for roughly 45% of the overall credit derivatives market. This note examines developments in the CDS market with a particular focus on the segments where the reference assets are sovereign obligations. Sovereign CDSs, which benefited from the standardisation of contract form and definitions in 1998 and 1999 as well as successful execution in the case of recent defaults, are considered the most liquid credit derivative instruments in emerging markets. Particularly as their liquidity increases, sovereign CDSs have the potential to supplement and increase efficiency in underlying sovereign bond markets.3 This special feature begins by briefly outlining the function and structure of credit default swaps. We then review the data provided by CreditTrade, one of the major trading platforms for credit derivatives, and use this as a basis for comparing sovereign with corporate and bank CDSs across a number of dimensions, including concentration of quotes by name of the reference asset, rating composition, maturity and pricing. 1 Chamaree Suthiphongchai was seconded to the BIS by the Bank of Thailand while this special feature was being researched. The views expr