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Don founded Kamakura Corporation in April 1990 and currently serves as its chairman and chief executive officer where he focuses on enterprise wide risk management and modern credit risk technology. His primary financial consulting and research interests involve the practical application of leading edge financial theory to solve critical financial risk management problems. Don was elected to the 50 member RISK Magazine Hall of Fame in 2002 for his work at Kamakura. Read More

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Kamakura Blog

Jul 15

Written by: Donald van Deventer
7/15/2015 3:59 AM 

The near-bankruptcy of Puerto Rico and the actual bankruptcy of Detroit brings even more pressure on municipal bond investors and related exchange-traded funds like (HYD) (NUV) (PML) (PZA) (IIM) (NIO) (VMO) specializing in municipal bonds to heighten risk management and to hedge where appropriate. One potential tool in that regard is the single name credit default swap market, which is featured almost constantly in discussions of municipal entity credit risk.

The purpose of this note is to bring clarity and precision to discussions of municipal credit default swaps by providing facts from the Depository Trust & Clearing Corporation trade warehouse. Take the case of Puerto Rico, for example. Summary data aggregated over many weeks by DTCC shows extremely modest volume in Puerto Rico credit default swaps. The weekly DTCC volume data, however, says that Puerto Rico credit default swaps have never traded in any week since the DTCC began reporting weekly on trading volume beginning with the week ended July 16, 2010. The author is grateful to Cate Long for pointing out this contradiction in the DTCC data. As yet, the contradiction has not been explained by DTCC.

Whether trading volume in Puerto Rico credit default swaps is zero or nearly zero is not relevant to the main point. In fact, only 12 municipal or sub-sovereign names have ever been reported as trades to the DTCC trade warehouse during the 2010-2015 period. This note explains the details.

Municipal Credit Default Swap Analysis
Kamakura Corporation has been reporting semi-annually on the credit default swap trading volume reported by the DTCC. The most recent report from Kamakura Corporation analyzes the trading in 1,256 reference names in the 259 weeks ended June 26, 2015 . Today’s analysis is a further update of the January 15, 2015 Kamakura Corporation report on weekly credit default swap trading volume for sub-sovereigns and municipals among 1,239 reference names that had traded in the 233 weeks ended December 26, 2014. The study found, unfortunately, that (in the words of Gertrude Stein) “there is no there there.”

The data used in this study consists of CDS trades reported by Depository Trust & Clearing Corporation (“DTCC”) during the 259 week period ending June 26, 2015. The weekly trade information is from the Section IV reports from DTCC. The data is described this way in the DTCC document “Explanation of Trade Information Warehouse Data” (May, 2011):

“Section IV (Weekly Transaction Activity) provides weekly activity where market participants were engaging in market risk transfer activity. The transaction types include new trades between two parties, a termination of an existing transaction, or the assignment of an existing transaction to a third party. Section IV excludes transactions which did not result in a change in the market risk position of the market participants, and are not market activity. For example, central counterparty clearing, and portfolio compression both terminate existing transactions and re-book new transactions or amend existing transactions. These transactions still maintain the same risk profile and consequently are not included as ‘market risk transfer activity.’”

As always, our emphasis is not on gross trading volume. As of June 26, 2015, dealer-dealer volume was 59.32% of 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. Accordingly, we make the following adjustments to the weekly number of trades reported by DTCC for each municipal and sub-sovereign reference name:

  1. We divide each weekly number of trades by 5 to convert weekly trading volume to an average daily volume for that week.
  2. From that gross daily average number of trades, we classify 59.32% of trades as “dealer-dealer” trades, using the average “dealer-dealer” share of trades in the DTCC trade warehouse as of June 26, 2015.
  3. The remaining 40.68% is classified as daily average “non-dealer” volume, the focus of the reporting below.

Important note: the trading averages for each reference name are reported only for those weeks in which there were trades. In other words, the averages are conditional on trades taking place.

Daily Non-Dealer Trading Volume for Municipal and Sub-Sovereign Reference Names
Of the 1,256 reference names for which DTCC reported credit default swap trades in the 259 week period, only 12 were sub-sovereigns of any type. The State of Connecticut is the only new sub-sovereign or municipal reference name added in the last 26 weeks.

  • Hong Kong Special Administrative Region
  • State of California
  • State of Connecticut
  • State of Florida
  • State of Illinois
  • State of Michigan
  • State of New Jersey
  • State of New York
  • State of Ohio
  • State of Texas
  • The City of New York
  • The Commonwealth of Massachusetts

There is no “Puerto Rico” on this list for the reasons explained above. This contrasts with the daily trades in the bonds of various Puerto Rico entities featured in this recent study. Note also that there is no Detroit entity on this list and not a single one of the California cities that have recently declared bankruptcy.

The total notional principal traded on all of these entities from July 2010 through June 26, 2015 is shown in this graph: 


Volume has definitely decreased in the last six months, after hitting record levels for a number of the reference names in the second half of 2014. Even those record levels, however, are still small compared to trading in sovereign entities.

The distribution of the daily average non-dealer trading volume in these 12 municipal entities, using the weekly averages over the 259 week period, is given in this simple histogram: 


Eleven of the 12 reference names were in the United States and 10 of the 12 reference names were U.S. states. The only cities on which credit default swaps had any trades in the 259 weeks ended June 26, 2015 were the City of New York and Hong Kong. We can summarize the trading volume in these 12 reference names as follows:

  • The highest ranking reference name in terms of trading volume was State of California. The State of California ranked 822nd of the 1,256 reference names reported by the DTCC.
  • The median number of non-dealer trades per day on all 12 reference names over the 259 week period was 0.3 trades per day.
  • Conditional on trades taking place, Hong Kong had the highest daily average non-dealer volume at $13.0 million.
  • The highest number of gross trades in one week was 173, which is the equivalent of 34.6 gross trades per day and 14.1 non-dealer trades per day. This data is for the State of California in the week ended September 21, 2012.

Over all of the weekly observations for the 12 entities on which trading was reported, the daily average trading volume is shown here: 


Overall, there were only 788 observations in which one of these 12 entities had a credit default swap trade in the 259 weeks ending June 26, 2015. Out of the total number of potential observations, 12 x 259 = 3,108, the number of observations with no trades was 2,320 or 74.6% of the total. The 99 th percentile in trading volume of the 788 non-zero observations was 3.7 non-dealer trades per day. The week by week gross trading volume (number of contracts) for the State of California over the full 259 week period ending June 26, 2015 is given in this chart: 


The weekly totals for gross notional principal trading in the State of California is shown in the next graph: 


In spite of the readily available DTCC trading volume data, journalists and data vendors persist in implying there is actual trading volume in municipal reference names when in fact there is almost always zero trading volume.

Donald R. van Deventer
Kamakura Corporation
July 15, 2015

Copyright ©2015 Donald van Deventer