CDS in muniland – There is no “there” there
On January 11, 2012, we looked at weekly credit default swap trading volume for subsovereigns and municipals among 1,090 90 reference names that had traded in the 77 weeks ended December 30, 2011. We found, unfortunately, that (in the words of Gertrude Stein) “there is no there there.” In this blog, we update our CDS volume analysis for subsovereigns and municipals for the 103 weeks ended June 29, 2012. Alas, our conclusion is unchanged.
Kamakura documents that there is very little volume in muni CDS trading, and most of it is done between dealers. Essentially it’s an artificial market with very few trades outside the dealer community. Kamakura, in their analysis, strips away the trades that dealers are doing between themselves:
As always, our emphasis is not on gross trading volume. As of September 7, 2012, dealer-dealer volume was 76.00 percent in the single name credit default swap market and it would be nearly costless for dealers to inflate gross trading volume by trading among themselves. Instead, we focus on “end user” trading where at least one of the parties to a trade is not a dealer.
The muni CDS market has been quiet for some time. Much of that is due to its relative illiquidity, a muni analyst in New York said.
For one, the muni CDS market isn’t very deep, with few brokers quoting them, he said. Also, they’re not widely utilized because the real-money buyer doesn’t have a lot of interest in the product.
“There’s a really limited global macro audience, which is effectively what this market would need,” the analyst said. In addition, there’s a taxable consequence for muni CDS. Investors must pay taxes on a trade that results in a gain, he said.
“For a lot of funds and traditional munis, you can’t do that inside the prospectus,” the analyst said. “So, you’re left with a bit of an illiquid market.”
Kamakura’s chart above shows all trades for California CDS. Subtracting non-dealer trades would reduce the number of trades by 76%. Only 20 weeks over the last two years had total trades that were above single digits. Kamakura calculates that average real money trades (non dealer-to-dealer trades) have been 0.39 trades per day over the last year. This is called trading by appointment, and it means that dealers can essentially control market activity and prices. Since this market is currently done over-the-counter (off exchange) there is no way to verify the accuracy of price quotes. Currently no regulator is overseeing this market (the SEC will oversee this space once the new Dodd-Frank rules are complete).
Muniland does not need credit default swaps. They were developed by dealers and that is the only place that they have found any traction. I expect volume will continue trending down.