David Kelly, director of credit products at data analytics provider Quantifi, said the new indexed CCDS ought to alleviate several simulation problems that existed with original CCDS. “Doing this on a single-name by single-name basis has never been efficient in dealing with counterparty risk,” he said. “Most of the risk has to be dealt with on an index or portfolio-style basis.”
Calculating CCDS is similar to calculating credit valuation adjustment, added Kelly. “You can look at your hedge portfolio, your CCDS portfolio, independently of your counterparty portfolio and add them together so exposure is going to move together.”
With implementation of Basel III approaching by 2013, participants say it helps that the swap can be marked to market daily. If there is a credit event, for example, the reference swap is valued and the CCDS is settled as if it were a regular CDS with a notional equal to that mark-to-market value.
Asset swap portfolios or banks can buy protection contingent on rates going higher, for example. A standard five-year CDS index position would be put on, referencing an interest rate swap with the same effective maturity.
Having the ability to cover interest rate exposure along with counterparty exposure in one trade is appealing. “The new product will give the market a new dimension – the ability to hedge macro correlation between interest rates and credit,” said the person familiar with the launch.
The timing of the product is also good, according to Quantifi’s Kelly, since more banks are looking at mitigating counterparty exposures. “A lot of the second-tier regional US banks are promising they want to have these in-depth discussions in the first quarter of 2012,” he said.
Market participants agree that CCDS is likely to get more of a following this time round. “The index idea is appealing. Unlike having a fixed notional like regular CDS, the amount of protection fluctuates on these, which also makes it a more effective hedge,” said one credit portfolio manager.
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