Traders wipe $1T from credit swap market before overhaul

Credit derivatives traders cut $1 trillion of outstanding positions last month as they prepare for the market's biggest overhaul.

The total amount of money at risk with credit-default swaps dropped to $17.1 trillion on Sept. 26 from $18.3 trillion on Aug. 29, according to the Depository Trust & Clearing Corp., which runs a central registry for the market. The numbers don't account for offsetting contracts.

Traders are closing positions as they prepare to buy contracts governed by updated rules that take effect on Oct. 6, when benchmark indexes roll into the series. The overhaul seeks to fix flaws in sovereign and bank swaps that prevented some insurance contracts from paying out as intended since the financial crisis.

"With the new change in definitions being implemented at an index level, this is likely to be a very active roll," Barclays Plc credit analysts led by Soren Willemann in London, wrote in a note to investors. "On the Financials side, clients have been removing their risk on legacy series."

Payouts on swaps linked to Dutch lender SNS Reaal NV covered as little as 4.5 percent of losses on bonds seized when the government nationalized the country's fourth-largest bank to prevent it from collapsing under bad real estate loans.

Trigger Swaps

As part of the changes, the list of events triggering swaps is being expanded to include bail-ins, in which investors are forced by regulators or governments to contribute to bank rescues. The new definitions also explicitly insure against debt writedowns, bond exchanges or conversions of debt into equity.

More than 1,400 investors agreed to automatically convert trades on most companies to the new terms, according to a list of firms on ISDA's website. Existing swaps tied to banks, governments and some companies won't be changed and investors may choose to exit those trades and buy new ones with the improved terms.

Outstanding trades on individual entities covered a net $778 billion of debt at the end of last week, compared with $821 billion four weeks earlier, DTCC data show. Index trades dropped to by more than $60 billion to cover a net $1.2 trillion in the period.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. They're used to hedge against losses or speculate on creditworthiness.