Voluntary terminations of credit default swap contracts

BIS Quarterly Review  |  December 2008  | 
08 December 2008

(Extract from page 33 of BIS Quarterly Review, December 2008)

Turmoil in credit markets and money markets in the first half of 2008 led market participants to engage in a significantly higher number of multilateral terminations of credit default swap (CDS) contracts. As a result, notional amounts outstanding of CDS contracts saw a decline, for the first period ever since publication of the statistics began in December 2004, of 1% compared with the notional amounts outstanding at the end of 2007 (Graph A, left-hand panel).

The decline to a large extent reflects unusually large volumes of voluntary multilateral terminations, or "tear-ups", of outstanding CDS contracts, which totalled $17.4 trillion, mainly in the multi-name segment (centre panel). Without these terminations, the outstanding notional amounts would have increased by nearly 30%. Terminations were mainly in CDS indices (right-hand panel) and were more pronounced after credit spreads widened. Although most outstanding CDS contracts continued to be between reporting dealers, this segment remained unchanged in terms of outstanding size. In contrast, the outstanding contracts between dealers and other financial institutions declined by 7%. The decrease for insurance companies was 21%, while that for securities firms, the largest segment, was 2%.

Since 2003, the private firm TriOptima has been offering multilateral termination services to OTC derivatives dealers, initially for interest rate swaps and subsequently for CDS. A termination cycle consists of two steps. Dealers first provide contract-by-contract information on their derivatives positions, and the firm then checks whether each individual contract is reported by both counterparties with identical terms. In a second step, TriOptima computes a set of bilateral contracts between participants that provides the same net exposures but lowers gross exposures.

More recently, Markit, a specialised CDS data manager, and Creditex, a CDS broker, initiated so-called "compression runs" for single-name CDS contracts. The first compression run ended on 27 August 2008. By end-November, 26 compression runs, 14 in Europe and 12 in the United States, had resulted in a total gross reduction in notional amounts outstanding of single-name CDS contracts in excess of $1.1 trillion.