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IMF: Evidence does not support the ban on naked SCDS purchases – Sober Look

This is a syndicated repost courtesy of Sober Look. To view original, click here. Reposted with permission.

As discussed back in September (see post), the hysteria over sovereign CDS (SCDS) within the European Commission and other governing organizations has been completely overblown. Sovereign CDS has been more of a “canary in a coal mine”, while EU politicians, bureaucrats, and often the public would sometimes prefer that the world does not know that their “sovereign canary” has died.

The IMF recently came out with a report confirming that much of the regulatory madness governing SCDS within the EU is unproductive. And a big part of the regulatory effort has in fact focused on the wrong risks.

IMF: – … the evidence here does not support the need to ban purchases of naked SCDS protection. Such bans may reduce SCDS market liquidity to the point where these instruments are less effective as hedges and less useful as indicators of market-implied credit risk. In fact, in the wake of the European ban, SCDS market liquidity already seems to be tailing off , although the effects of the ban are hard to distinguish from the influence of other events that have reduced perceived sovereign credit risk. In any case, concerns about spillovers and contagion effects from SCDS markets could be more effectively dealt with by mitigating any detrimental outcomes from the underlying interlinkages and opaque information. Hence, efforts to lower risks in the over-the-counter derivatives market, such as mandating better disclosure, encouraging central clearing, and requiring the posting of appropriate collateral, would likely alleviate most SCDS concerns.

As much as we all were fascinated by the Greek CDS settlement, in the bigger scheme of things it was a non-event (see post). Once again it’s worth pointing out that CDS is not insurance and operates more like a futures contract with margin calls taking place long before there is an event.

Also it’s important to note that with all the fears of systemic risks, sovereign CDS represents only around 1% of the daily trading volume of the credit default swaps market – which is completely dominated by corporate CDS.

 Source: DTCC Deriv/SERV

Moreover, most of this trading volume is in the various index CDS such as iTraxx and CDX. And those products are not materially different from index futures which we all know and love. So for those who like to pontificate on the evils of the sovereign credit default swaps markets (and this includes the European Commission), please get your facts straight.

SoberLook.com

This is a syndicated post, which originally appeared at Sober LookView original post.

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