The DIY way to track derivatives

July 1, 2009

With all the talk about greater regulation of derivatives, there already is one way for average investors to get a glimpse into this murky world of high finance–although calling it a glimpse might be overstating things.

A three-year-old electronic registry managed by The Depository Trust and Clearing Corporation currently captures information regarding more than 95% of the world’s credit default swap transactions. The DTCC gathers information on the parties to a CDS transaction, the name of the underlying bond that a CDS buyer is obtaining default insurance on, the value of the transaction and the termination date of the trade. 

A CDS, of course, is an insurance-like derivative product that enables a trader to protect himself in the event of a default on a bond. The big controversy with CDS is that a trader need not own the bond to buy this insurance. So in effect, a trader can profit from a company’s default without owning any of its debt–speculate on the prospect of a bankrutpcy is you will.

The DTTC uses all the information it gets on these CDS trades to generate transaction reports called “production-trade warehouse” reports. The trouble is these reports are not available to the public. Regulators get to see them and so do the parties on either side of a CDS transaction. But generally, the only time the public gets to see these transaction reports is when they become the subject of litigation.

Still, the DTCC does publish weekly updates about changes in the size of the CDS market on its website. These weekly updates allow investors to get a big picture view of where traders are buying CDS protection.

Not surprisingly, the DTCC data shows that the largest notional dollar value of CDS contracts is for ones written on bonds sold by financial companies. But right behind the financials with a large number of open CDS contracts are debt notes sold by consumer services companies and sovereign governments.

Now, of course, the CDS market is just one small sliver of the derivatives world. But it’s the corner that has gotten the most attention from regulators in the wake of Lehman Brothers collapse and the big bailout of AIG.

These weekly updates from the DTCC are an imperfect way for tracking changes in the CDS market. I’d like to see more specific information published about the changes in the number of CDS contracts written on specific company names. And some information about the hedge funds and other market participants that are particularly heavy buyers of CDS.

But the DTCC weekly updates are better than nothing.

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