Trading volume in the bond and credit default swap markets, particularly the sovereign credit default swap market, is one of the key drivers of profit for major dealers like Bank of America (BAC), Barclays Bank PLC, BNP Paribas (BNPZY), Citigroup (C), Credit Suisse (CS), Deutsche Bank (DB), Goldman Sachs (GS), HSBC Holdings (HSBC), JPMorgan Chase (JPM), Morgan Stanley (MS), The Royal Bank of Scotland Group PLC (RBS), and UBS AG (UBS). This update adds some details to the nice Wall Street Journal study “Where did Europe’s Sovereign CDS Trading Go?” which analyzes the European Commission’s ban on the short sales of sovereign credit default swaps.
That bank,announced on July 5, 2012, is explained in thistext from the European Commission. The regulation became effective on November 1, 2012. The full text of the regulationis available from the European Commission website.
Conclusions: If there is sector of the credit default swap market which has shown decent trading activity over the last 207 weeks, it is the sovereign sector, primarily the top 5 or 6 reference names. Trading volume, however, has declined in a statistically significant way for 11 of the 12 most heavily traded Member States of the European Union. We explain how these conclusions were reached in what follows.
The Analysis of Sovereign Credit Default Swap Trading Volume
In this note, we analyze the trading volume for all sovereign reference names as reported by the Depository Trust & Clearing Corporation. We also analyze the impact on volume of the European Commission’s ban on short sales of sovereign debt. The European Commission regulation bans the short sale of credit default swaps on issuers that meet the following definition in the act (Chapter 1, Article 2, section 1):
“(d) ‘sovereign issuer’ means any of the following that issues debt instruments:
(i) The Union;
(ii) A Member State, including a government department, an agency, or a special purpose vehicle of the Member State;
(iii) In the case of a federal Member State, a member of the federation;
(iv) A special purpose vehicle for several Member States;
(v) An international financial institution established by two or more Member States which has the purpose of mobilizing funding and provide financial assistance to the benefit of its members that are experiencing or threatened by severe financing problems; or
(vi) The European Investment Bank”
The Member States of the European Union are listed here along with their year of entry into the Union:
- Austria (1995)
- Belgium (1952)
- Bulgaria (2007)
- Croatia (2013)
- Cyprus (2004)
- Czech Republic (2004)
- Denmark (1973)
- Estonia (2004)
- Finland (1995)
- France (1952)
- Germany (1952)
- Greece (1981)
- Hungary (2004)
- Ireland (1973)
- Italy (1952)
- Latvia (2004)
- Lithuania (2004)
- Luxembourg (1952)
- Malta (2004)
- Netherlands (1952)
- Poland (2004)
- Portugal (1986)
- Romania (2007)
- Slovakia (2004)
- Slovenia (2004)
- Spain (1986)
- Sweden (1995)
- United Kingdom (1973)
On July 9, 2014, Kamakura Corporation reviewed trading volume in credit default swaps for 1,206 reference names reported by the Depository Trust & Clearing Corporation and found that only 5 reference names in the world had averaged more than 10 or non-dealer trades per day in the 207 weeks ended on June 27, 2014. In this note, we look at weekly credit default swap trading volume for sovereigns among those 1,206 reference names. This report is an update of the Kamakura sovereign credit default swap trading volume analysis of February 13, 2014. We continue to find that a small set of sovereigns leads trading volume in single name credit default swaps: Spain, Italy, Brazil, and France. Beyond those names, trading volume drops off rapidly.
The weekly trade information we analyze 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 discussed in the July 9 report, our emphasis is not on gross trading volume. As of January 10, 2014, dealer-dealer volume is 72.48%% 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. Accordingly, we make the following adjustments to the weekly number of trades reported by DTCC for each sovereign reference name:
- We divide each weekly number of trades by 5 to convert weekly trading volume to an average daily volume for that week.
- From that gross daily average number of trades, we classify 72.48% of trades as “dealer-dealer” trades, using the average “dealer-dealer” share of trades in the DTCC trade warehouse on January 10, 2014.
- The remaining 27.52% 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 Sovereign Reference Names
Of the 1,206 reference names for which DTCC reported credit default swap trades in the 207 week period, only 59 were sovereigns. 26 of the 28 Member States of the European Union have had some credit default swap trading during the 207 weeks ended June 27, 2014. Those members of the European Union are highlighted in bold:
ARAB REPUBLIC OF EGYPT
BANQUE CENTRALE DE TUNISIE
BOLIVARIAN REPUBLIC OF VENEZUELA
COMMONWEALTH OF AUSTRALIA
FEDERAL REPUBLIC OF GERMANY
EDERATIVE REPUBLIC OF BRAZIL
KINGDOM OF BELGIUM
KINGDOM OF DENMARK
KINGDOM OF NORWAY
KINGDOM OF SAUDI ARABIA
KINGDOM OF SPAIN
KINGDOM OF SWEDEN
KINGDOM OF THAILAND
KINGDOM OF THE NETHERLANDS
PEOPLES REPUBLIC OF CHINA
REPUBLIC OF AUSTRIA
REPUBLIC OF BULGARIA
REPUBLIC OF CHILE
REPUBLIC OF COLOMBIA
REPUBLIC OF CROATIA
REPUBLIC OF CYPRUS
REPUBLIC OF ESTONIA
REPUBLIC OF FINLAND
REPUBLIC OF HUNGARY
REPUBLIC OF ICELAND
REPUBLIC OF INDONESIA
REPUBLIC OF ITALY
REPUBLIC OF KAZAKHSTAN
REPUBLIC OF KOREA
REPUBLIC OF LATVIA
REPUBLIC OF LITHUANIA
REPUBLIC OF PANAMA
REPUBLIC OF PERU
REPUBLIC OF POLAND
REPUBLIC OF SLOVENIA
REPUBLIC OF SOUTH AFRICA
REPUBLIC OF THE PHILIPPINES
REPUBLIC OF TURKEY
SOCIALIST REPUBLIC OF VIETNAM
STATE OF ISRAEL
STATE OF QATAR
UNITED KINGDOM OF GREAT BRITAIN AND NORTHERN IRELAND
UNITED MEXICAN STATES
UNITED STATES OF AMERICA
No credit default swap trades were reported in the 207 weeks ending June 27, 2014 for the other 125 sovereigns which have default probabilities in Kamakura Risk Information Services sovereign default service.
Analysis of Daily Average Non-Dealer Trades Per Day
We first analyze the 207 week averages for the 59 sovereigns for which CDS trading volume was greater than zero during the 207 weeks ending June 27, 2014. The daily average non-dealer trading volume, calculated as described above, was distributed as follows:
The conclusions that can be drawn from this table are summarized here:
- 75% of the 59 sovereigns averaged less than 4.46 non-dealer CDS trade per day.
- 95% of the 59 sovereigns averaged less than 13.61 non-dealer CDS trades per day.
- 99% of the 59 sovereigns averaged less than 15.62 non-dealer CDS trades per day.
- The average 207 week daily average number of non-dealer trades per day for the 59 sovereigns was 3.23 trades per day
- The median 207 week daily average number of non-dealer trades per day was 1.38 trades per day
In spite of the European Commission ban on short sales, we conclude that trading volume for the most active sovereigns is higher than it is for the most active corporations, which is only logical given that such sovereigns issue more debt than the most active corporations. The correlation between trading volume and debt outstanding is weak, however, with the United States well down on the ranking of trade volume in spite of the high volume of U.S. debt outstanding.
Analyzing Trading Volume in Aggregate
We now analyze all 207 weeks of data, not just the average over that period, for all 59 sovereigns for which DTCC reported non-zero trade volume. There were 12,213 (= 59 x 207) observations on CDS trading volume for these 59 sovereigns, and there were no trades for 1,202 observations, 9.8% of the total. The distribution of non-dealer trades per day over the 11,011 non-zero observations is summarized in the following chart:
One can draw the following conclusions over 11,011 non-zero weekly observations:
- 75% of the observations showed 4.18 non-dealer trade per day or less
- 95% of the observations showed 14.20 non-dealer trades per day or less
- 99% of the observations showed 27.19 non-dealer trades per day or less
- There were only 9 observations that showed more than 50 non-dealer trades per day or more
- The highest volume week was February 10, 2012, during which Brazil traded 79.48 non-dealer trades per day.
While the sovereign CDS market shows more non-dealer CDS daily average volume than the corporate market, trading is concentrated in a relatively few names. 125 sovereigns had no CDS trades at all over the 207 week period studied.
Detailed Information on CDS Trading Volume by Individual Reference Name
The weekly, daily, and daily non-dealer trading volume for the top 25 sovereign names is given here:
The number of contracts traded for the volume leader, Brazil, is shown in this graph:
The notional principal of these contracts traded on Brazil is shown in this graph of the 207 weeks of trading ended June 27, 2014:
Analysis of the Impact of the European Commission Short Sale Ban
Unlike the Wall Street Journal analysis cited above, our focus is solely on single name credit default swap trading in sovereign reference names. In analyzing whether or not the European Commission ban on short sales of sovereign debt has reduced credit default swap trading in European Union Member States, the task is complicated by the randomness in trading volume both before and after the ban took effect November 1, 2012. Accordingly, we perform the normal tests of statistical significance in order to determine whether a change in the mean level of non-dealer daily average contracts traded before and after the ban is statistically significant or not (i.e. the change could be due simply to the “noise” in trading volume over time). The results of the exercise are reported in this table:
We reach the following conclusions:
- Trading volume, as measured by daily average non-dealer credit default swaps traded, declined for 16 of the 26 European Union Member States on which there was credit default swap trading.
- This decline in trading volume was statistically significant at the 95% confidence level for 11 of the 16 Member States showing a trading decrease
- 10 of the 26 member states actually showed a trading volume increase, and another 5 member firms showed a trading decrease that was not statistically significant at the 95% confidence level.
- 11 of the 12 member states with the heaviest overall credit default swap trading volume showed a statistically significant decrease in trading volume. Note that there were literally no trades in the Hellenic Republic after the ban so the normal significance tests could not be performed. We nonetheless included the Hellenic Republic in the “statistically significant” category for obvious reasons.
The graph below shows the gross weekly number of trades by all counterparties in the Kingdom of Spain for the 207 weeks ended December 31, 2013. The decrease in volume after November 1, 2012 is quite striking.
The next graph shows the total amount of notional principal of credit default swap trading in the Kingdom of Spain over the same 207 week period.
Again, the decrease in trading volume after the November 1, 2012 ban took effect is plain to see even without the statistical backup, although the increase in volume in recent weeks is sizable.
If there is sector of the credit default swap market which has shown decent trading activity over the last 207 weeks, it is the sovereign sector, primarily the top 5 or 6 reference names. Trading volume, however, has declined in a statistically significant way for 11 of the 12 most heavily traded Member States of the European Union. Only time will tell if the trading volume in the sovereign sector will regain its vitality or languish in the same “zombie state” as most other sectors of the single name credit default swap market.
Donald R. van Deventer
Honolulu, July 14, 2014