CDS Market Structure and Risk Flows: The Dutch Case

Abstract

Using new regulatory data, this paper contributes to the growing literature on derivatives markets and (systemic) risk, by providing a first account of the Dutch CDS market, investigating the factors that drive buying and selling of credit protection ('flow-of risk'), and analysing the impact of Brexit. We find that the CDS market has a 'core-periphery' structure in which Dutch banks are CDS sellers while insurance firms and pension funds (ICPF's) and 'other financial institutions' (OFIs) are buyers. When the volatility of a reference entity increases, the propensity to sell CDS decreases for banks and increases for ICPFs and OFIs. This hints at procyclical behaviour by banks and countercyclical behaviour by ICPFs and OFIs. The 'core-periphery' structure of the CDS market became more pronounced around Brexit events, making the CDS market more vulnerable to shocks emanating from 'systemic' players. Banks reduced net buying and selling of CDS protection on UK reference entities, while OFIs and investment funds became more dominant. This underpins the importance of adequate buyers for systemic institutions and extending the regulatory perimeter beyond banking.