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Part - VI

Currently, there are few accurate estimates of the current size of credit markets. A survey by the British Bankers Association last year estimated the London market for credit derivatives to be somewhere between $20 billion and $30 billion. An anecdotal survey conducted by CIBC, also in 1996, estimated the global credit derivatives market at somewhere around $40 billion. Other sources-all of them dealers-suggest the market in 1997 could grow as large as $100 billion. Other end-users have expressed similar fears about the depth of the market. "We would consider using total return swaps to change the credit profile of some of our held-to-maturity investments, but we are concerned about being able to unwind these transactions," adds an insurance executive at a New Jersey-based insurance company.

Although some of the liquidity deficit comes from the nature of credit itself (that is, every corporate or sovereign credit is unique and therefore not perfectly interchangeable), much of it results from shortfalls in market infrastructure that can be easily corrected. According to BZW's Usi, "The concern over liquidity in the credit derivatives market may be overblown. Consider how long it took for the nascent swap markets to build momentum. At this point in their evolution, the credit markets today are about where they should be."

One of the most critical hurdles to higher liquidity is perhaps one of the most mundane. Lawyerly wrangling routinely delays transactions because the International Swaps and Derivatives Association has yet to finalize documentation for basic credit derivatives structures or even for standard definitions of credit events such as defaults. For example, in a default swap conducted between two banks and intermediated by a broker, legal departments from both banks must develop and approve documentation. According to one broker, "Sometimes this can take as long as five days, a considerable impediment to liquidity."

All this gives interdealer brokers an increasingly important role to play, according to Garry Philip Rayner, director of credit and structured derivatives at Prebon Yamane. The broker's role in a credit derivatives transaction goes far beyond simply matching two sides of a deal; often it will include providing negotiation between two counterparties as they attempt to hash out the terms, choices and conditions of a deal. These terms and conditons can often create vehement disagreements between counterparties because of the idiosyncratic nature of many credit derivatives and the current deficit of standard documentation and terminology.

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* Contributed by -
Prashant Jadhav,
2nd Year PGeMBA (Finance),
Mumbai Educational Trust (MET) Schools of Management, Mumbai.