01 October 2013

ISDA: CDS Market Summary - Market Risk Transaction Activity

This research paper claims that in the post-compression era, market risk transaction activity, not notionals outstanding at a point in time, is the optimal measure for understanding and analysing CDS market activity.

Has the CDS market increased or decreased in size over the past several years? On the one hand, the aggregate level of CDS notional outstanding has decreased. This suggests a reduction in market activity. On closer examination however, it becomes apparent that this decrease in notional outstanding is attributable to portfolio compression, which is a widely used tool designed to eliminate transactions and reduce risk. Portfolio compression (also called trade tear-ups) has made a great impression on the CDS market.

A much better way to understand CDS market dynamics is by looking at trading activity in the market, as opposed to transactions outstanding at a point in time. The DTCC measures market risk transaction activity which refers to the volume of trading (using both transaction counts and notional amounts traded) related to new transactions that affect market risk. It provides a view into current levels of new market activity and enables comparisons of such activity between periods

Notionals outstanding, which historically has reflected market activity on a cumulative basis, is one way to measure the size of the CDS market. But compression greatly impacts this number. (Clearing also has an impact, in the opposite direction of compression, as one bilateral trade becomes two cleared trades.)

A better way to look at the relative dynamics of the CDS market is to analyse new market risk transaction activity. Market risk transaction activity includes the following transaction types: new trades between two parties, a termination of an existing transaction, or the new leg of a trade that has been assigned from one party to another.

Full paper

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