NEW YORK–(BUSINESS WIRE)–Sept. 24, 2003–Credit derivatives have been a positive development for the global financial system, facilitating enhanced risk transfer and dispersion, according to theupdated global credit derivatives survey published today by Fitch Ratings. While credit derivatives have been beneficial as a risk transference tool, the new report identifies weak disclosurestandards, the potential for unanticipated risk concentrations and the role of hedge funds as potential areas of concern.
‘On balance, Fitch believes that credit derivatives have been beneficial for the market,’ said Roger Merritt, managing director, Fitch Ratings. ‘Nevertheless, the agency believes there are risks that bear watching, including low financial transparency, informational asymmetries, potential risk concentrations, and the possible promotion of new forms of moral hazard within the banking system as the linkage between origination and management of credit risk becomes more attenuated. Further, traditional measures of financial strength and performance are at risk of becoming increasingly distorted in the absence of a minimum standard of disclosure regarding credit derivatives activities.’
Fitch’s updated global credit derivatives survey provides more insight into the burgeoning credit derivatives market. The rating agency surveyed approximately 200 global banks, insurance companies, reinsurers, financial guarantors and broker-dealers, focusing primarily on those ‘selling protection’ through credit derivatives and cash collateralized debt obligations (CDOs). In total, data from 181 institutions has been analysed and US$1.7 trillion of the market identified (US$1.8 trillion with cash CDOs).
According to the updated survey, Fitch found that the global banking industry has used the credit derivative market to transfer US$229 billion of credit risk, primarily to the insurance industry, which has sold US$381 billion of credit protection (including US$78 billion cash CDOs). As a sector, the largest sellers of credit protection were financial guarantors, which sold US$222 billion of protection (US$166 billion of credit derivatives and US$56 billion cash CDOs). Somewhat surprisingly regional banks also were identified as significant protection sellers, prompting further inquiry.
Fitch was not able to obtain information on the credit derivative activities of hedge funds, despite its efforts to survey 50 of the larger, more recognized funds. ‘While generally not rated, hedge funds are understood to represent one of the fastest growing segments of the credit derivatives market and thus play an increasingly influential role,’ said Ian Linnell, managing director, Fitch Ratings. ‘Fitch believes issues related to poor disclosure, transparency and counterparty risk could very well be exacerbated by the participation of these non-regulated entities.’
The updated survey includes greater detail concerning the ultimate acquisition of credit risk by type and nationality of institution. For example, the most frequently cited reference entities generally were those institutions with significant amounts of debt outstanding, with France Telecom cited most frequently. Additionally, there is greater detail on the credit quality of major market participants, trading versus hedging activities and counterparty risk. The market remains relatively concentrated in terms of major counterparties, with JP Morgan Chase ranked as the leading counterparty among survey participants. The report also provides further comment on the accounting for and regulatory reporting of credit derivatives.
The updated survey, ‘Global Credit Derivatives: A Qualified Success’, can be found on the agency’s web site, www.fitchratings.com, by linking to ‘Credit Market Research’ and clicking on ‘Research’.
