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Credit-Default Swaps on Italy, Spain Are Most Traded
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Credit-default swap traders wagered the most on debt of Italy, Spain and Deutsche Bank AG, according to a Depository Trust & Clearing Corp. report that gives the broadest data yet on the unregulated market.

A total $33.6 trillion of transactions are outstanding on governments, companies and asset-backed securities worldwide, based on gross numbers, the DTCC said in the report released on its Web site yesterday. After canceling out overlapping trades, investors have taken out a net $22.7 billion of contracts based on Italy's debt, $16.7 billion against Spain and $12.5 billion on Deutsche Bank of Frankfurt, the report shows.

``The bigger the outstanding amount of debt, the bigger the volume of credit-default swaps,'' said Philip Gisdakis, a Munich- based credit analyst at UniCredit SpA. ``Sovereigns have huge debt outstanding. Deutsche Bank has a huge balance sheet, so it's quite understandable it's at the top of the list.''

The DTCC, which operates a central registry of credit- default swap trades, released the data after U.S. authorities blamed the unregulated market for exacerbating the credit crisis that led to almost $690 billion in bank losses and writedowns.

The level of credit-default swaps reported by DTCC is smaller than previous estimates. The Bank for International Settlements estimated contracts of $57.9 trillion outstanding in May. DTCC's data may calm concerns that investors and dealers have too much at risk, said Brian Yelvington, a New York-based strategist at fixed-income research firm CreditSights Inc.

`Right Direction'

``Far too much mistrust has been engendered by the lack of transparency,'' Yelvington said. ``There's still a lot here that's not captured. But it's a step in the right direction.''

Trading in credit-default swaps, which pay the buyer face value in exchange for the underlying securities should a borrower fail to adhere to its debt agreements, exploded 100-fold during the past decade.

The credit-default swaps market has moved beyond its origins of protecting banks from loan losses to a way for hedge funds, insurance companies and asset managers to speculate on the creditworthiness of companies, governments and other borrowers, including homeowners. Billionaire investor Warren Buffett has called credit-default swaps a ``time bomb.''

The collapse of Lehman Brothers Holdings Inc. contributed to a decline in financial markets last month because no one knew how many credit-default swap contracts were outstanding on the securities firm, how many the company had written or who held them. They are private contracts between two parties, don't trade on an exchange and aren't processed through a central clearinghouse, making it virtually impossible for the public to asses the amount wagered on the debt. Estimates ranged as high as $400 billion, though the actual amount turned out to be $72 billion, the DTCC said.

Trading Data

After subtracting redundant trades, only $5.2 billion of trades actually changed hands, DTCC said last month, the first time it had released such information from its data warehouse.

Dealers have been trying to reduce the number of contracts outstanding by tearing up overlapping trades, helping reduce the net number of transactions and allaying concerns that the market was too large. The Federal Reserve and the European Central Bank are pushing dealers to create a clearinghouse to act as a counterparty on each trade, eliminating the risk of one side defaulting.

The DTCC, which is controlled by a board of members including JPMorgan Chase & Co. and Goldman Sachs Group Inc., doesn't list contracts on all companies, governments and other securities beyond the top 1,000 in the registry, on which there are a net of $183.3 billion. And there's not a clear accounting of what may exist beyond the registry.

Spain, Italy

Investors have focused wagers on debt of industries and countries that may be most affected by a credit crisis entering its 15th month. The Spanish economy is headed toward its first recession in 15 years amid a slump in its housing market and banking and finance shares have dropped as the credit seizure caused some to collapse.

Credit-default swaps on Italy were quoted at 107.5 basis points today, CMA Datavision prices on 10-year contracts show, after reaching a record 138 basis points on Oct. 24. The contracts have more than doubled since August. Today's price represents a cost of $107,500 a year to protect $10 million of debt for 10 years.

Contracts on Spain climbed to 112 basis points on Oct. 24, from about 47 basis points at the start of September. They have since dropped back to 78.5 basis points.

The ECB met with regulators, lenders and investors this week to discuss ways of increasing transparency in the default swaps market on its side of the Atlantic. A central counterparty is an ``appropriate solution'' for reducing risk, the ECB said in a statement. Auctions this week are meantime settling default swaps on debt of Iceland's three biggest banks.

GE Capital, Merrill

In total, about $15.4 trillion of transactions were linked to individual corporate, sovereign and asset-backed bonds worldwide at the end of October, the DTCC data showed. About $14.8 trillion was tied to indexes.

Among companies, GE Capital Corp., the finance arm of General Electric Co., New York-based Morgan Stanley, Merrill Lynch & Co. and Goldman Sachs Group Inc. had the biggest dollar amount of contracts tied to their debt on a net basis, after Deutsche Bank, Germany's biggest lender, DTCC said. New York- based Merrill agreed in September to sell itself to Bank of America Corp.

The net figures are the maximum that sellers would have to pay to buyers if the borrowers defaulted, DTCC said.

Netting Trades

Turkey, Italy, Brazil, Russia, GMAC LLC, and Merrill Lynch & Co. had the biggest gross amount of contracts outstanding on their debt as of Oct. 31. Turkey alone had $188.6 billion of default swaps written against its debt. The gross amount doesn't take into account offsetting trades. After netting the trades, there were $7.6 billion outstanding on Turkey.

The industry should ``get the word out about the small size of these risks compared to the notional amounts on which the contracts are based,'' said Mark Brickell, chief executive officer of Blackbird Holdings Inc., which provides an electronic trading system for derivatives, and former chairman of the International Swaps and Derivatives Association.

Criticism of the market intensified in September after the collapse of Lehman and the U.S. government's bailout of American International Group Inc., which faced bankruptcy after credit- rating downgrades forced it to post more than $10 billion in collateral on credit swap trades that had plunged in value.

Cox on Disclosure

U.S. Securities and Exchange Commission Chairman Christopher Cox called for authority to regulate the credit swaps market, saying the lack of disclosure and the web of connections between dealers in the market threatened the stability of the financial system. The Federal Reserve Bank of New York, which has spent the last three years pushing dealers to curb risks in the credit swaps market, last week said it welcomed the DTCC's disclosure.

``Publishing this data will provide greater transparency in a critical market,'' Tim Ryan, head of the Securities Industry and Financial Markets Association, said in a statement today. ``This is an important initiative upon which the industry will continue to build.''

By Shannon D. Harrington and Abigail Moses

Source > 
Bloomberg | Nov. 5

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