Senior Supervisors Group: CDS auction process working

In the report, Observations on management of recent credit default swap credit events, the SSG - a collection of regulators from North America, Europe and Japan - looked at how firms manage their CDS activities and positions following a credit event. The SSG based its findings on discussions with four major dealers, four buy-side firms, three services providers and the International Swaps and Derivatives Association.

Talks were principally focused on the effectiveness of management surrounding credit events that occurred in September and October 2008, involving the US government-sponsored entities Fannie Mae and Freddie Mac, Lehman Brothers, and Icelandic bank Landsbanki.

In general, participants said the auctions were managed in an orderly fashion, with no major operational disruptions or liquidity problems. Participation rates in auctions exceeded 95%, and those interviewed by the SSG said they were able to identify affected trades on the same day as the credit event occurred, largely because they had actively monitored high-risk names.

Nevertheless, some buy-side firms claimed there was a need for a more equitable auction process - citing flaws in the manner in which deliverable obligations were determined for Fannie Mae and Freddie Mac credit events. To help address this, they suggested using independent third-party firms to accept client orders during auctions to eliminate "any information asymmetry between dealers and buy-side firms, as well as to prevent dealers from potentially using its knowledge of positions to skew results".

Dealers dismissed this view, however, insisting auctions were designed to enable them to fulfil their roles as market makers and liquidity providers.

See also: Isda to publish auction settlement supplement, launches close-out protocol
New single-name CDS sparks hedging worries

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