Can the Credit Default Swap Market Be Salvaged? Issues for Borrowers and Investors

Abstract

Trading volumes in credit default swaps (CDS) have fallen by more than 75% since the 2008 financial crisis to less than $9 trillion notional amount outstanding as of June 2015. This dramatic decline in volumes comes, in part, because of new laws and regulations focused on reducing the risk of these over-the counter (OTC) derivatives products. Despite significant changes in the regulation of these products, there remain a number of defects in the market structure of OTC credit derivatives, flaws which arguably intensified the impact of the 2008 financial crisis and disadvantage both borrowers and investors. These defects in market structure limit competition, make it difficult for investors to understand the risks taken by large universal banks, create the potential for the manipulation of borrower credit spreads, and even affect the recognition of when default events occur under CDS contracts.