Creditex and Markit today announced a joint initiative to launch an industry-wide portfolio compression platform for the credit derivative market. This process is the first of its kind and represents a significant improvement over previous tear-up processes. The platform supports commitments made by major market participants to the Federal Reserve Bank of New York relating to improved operational efficiency and risk reduction.
Developed in response to a request by the International Swaps and Derivatives Association (ISDA) on behalf of major credit derivative dealers, the platform will reduce operational risk and improve capital efficiency by reducing the number of trades and the gross notional outstanding value of single-name credit default swaps (CDS) held by dealers. This will be achieved through a multi-lateral portfolio "compression" or "tear-up" process that is scheduled to launch in the third quarter of 2008.
The new compression approach improves on previous tear-up processes by delivering significantly better compression results while leaving market risk profiles unchanged. The process involves terminating existing trades and replacing them with a far fewer number of new "replacement trades" which have the same risk profile and cash flows as the initial portfolio, but with less capital exposure. The initiative, available to both the U.S. and European CDS markets, will be managed jointly by Creditex and Markit and has the support of 13 major CDS market participants.
Sunil Hirani, chief executive officer of Creditex, said: "We are pleased to be a part of a collaborative effort with Markit and major industry participants to strengthen the CDS market infrastructure. We believe this foundational effort will bring immediate and longer-term benefits to the CDS market as highlighted and called for by market participants and regulators."
Kevin Gould, executive vice president and head of Data Products and Analytics at Markit, said: "This initiative will significantly reduce operational risk within the CDS market and the solution leverages the individual strengths of both Creditex and Markit. We expect the process to be run regularly and as such it is likely to become an integral part of the market infrastructure."
The compression initiative is the second major industry effort on which Creditex and Markit have collaborated with ISDA and the major dealers to provide critical market infrastructure. The two companies are official co-administrators of ISDA cash settlement auctions which allow for efficient and orderly settlement of credit derivative contracts following a corporate default. The cash settlement auction mechanism was launched in 2005 and has since been relied upon in connection with nine major corporate defaults, most recently that of Quebecor World Inc.