In this report, we update the Kamakura Corporation analysis of trading volume in single name credit default swaps as reported by the Depository Trust & Clearing Corporation ("DTCC"). In today's analysis, we look at 181 weeks of single name credit default swap trading volume data from the week ended July 16, 2010 through December 27, 2013 for 1,179 reference names.
Conclusion: We continue to find minimal "end user" trade volume for the overwhelming majority of the reference names. The exception is the trading of credit default swaps on sovereign reference names. The lack of volume in the single name credit default swap market has important implications for the profitability of dealers like JPMorgan Chase & Co. (JPM), Goldman Sachs (GS), Citigroup Inc. (C), Morgan Stanley (MS), and many other very large financial institutions. The lack of volume should also lead any sophisticated investor, institutional or retail, to reject journalists' use of CDS quotes unless those quoted figures are reported alongside actual CDS trading volume.
Prior reports from Kamakura Corporation on overall volume in the single name credit default swap market were published for the 155 weeks ended June 28, 2013, the 129 weeks ended December 30, 2012, and the 103 weeks ended June 29, 2012.
In this analysis, we make use of the degree to which trading in single name credit default swaps was trading between two dealers as defined by the Depository Trust & Clearing Corporation ("DTCC"). In this study, we use the percentage of dealer-dealer trades still open in the DTCC trade warehouse as of January 10, 2014: 72.48%.
We analyze CDS trading volume for the 1,179 reference names for which CDS trades were reported by DTCC during the 181 week period ended December 27, 2013. 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.'"
Our emphasis is not on gross trading volume. As mentioned above, 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 reference name:
- We divide each weekly number of trades by 5 to convert weekly 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 January 10, 2014 "dealer-dealer" share of trades in the DTCC trade warehouse.
- The remaining 27.52% is classified as daily average "non-dealer" volume, the focus of the reporting below.
Daily Non-Dealer Trading Volume for 1,144 Reference Names
Before reporting on the 1,179 reference names in the DTCC warehouse, it is important to note a very important fact. Kamakura Risk Information Services' default probability service produces daily default probabilities on 34,639 public firms around the world, including 5,585 in the United States. The DTCC weekly reports were designed to report the top 1,000 reference names ranked by daily credit default swap trading volume. In none of the 181 weeks, however, were there as many as 1,000 reference names reported by DTCC. In essence, the weekly reports contain every reference name in which there was non-zero trading volume in the DTCC. For all other reference names, then, trading volume was zero. This means that almost 33,500 of the public firms in KRIS had zero credit default swap trading volume over the entire 181 week period studied. We now turn to the 1,179 reference names for which there was at least 1 credit default swap trade during the 181 week period.
We first analyzed daily average non-dealer CDS trading volume by calculating the daily average number of contracts traded, as described above, for all 1,179 reference names for the entire 181 week period. The distribution of the reference names by non-dealer daily average trading volume contains some very surprising results, shown in this histogram of 181 week daily average of non-dealer contracts traded per day:
Among the surprising conclusions are these facts:
- Only 4 reference names averaged more than 10 non-dealer trades per day
- Only 19 reference names averaged more than 5 non-dealer trades per day
- 99% of references names averaged less than 6.13 non-dealer trades per day
- 95% of reference names averaged less than 3.40 non-dealer trades per day
- 75% of reference names averaged less than 1.48 non-dealer trades per day
- The median reference name averaged 0.78 non-dealer trades per day
These trading volumes are very small to say the least, and it continues to be astonishing that financial journalists have not made the appropriate disclaimers when quoting "CDS prices" (many of which are quotes, not trades) for specific reference names. The chart below lists the top 25 reference names ranked by the non-dealer daily average number of trades over the 181 week period. We also display the 181 week daily average non-dealer notional principal traded. Please note that the non-dealer percentage of trades is only available for the entire warehouse of deals at DTCC. We have assumed the same non-dealer percentage applies to each reference name as a first approximation.
The most actively traded reference name was the Kingdom of Spain, for whom gross weekly trading volume (including dealer-dealer trades) is graphed here in terms of contracts:
The weekly gross notional amount of trading in Kingdom of Spain is graphed in the next chart:
In order to better understand the data, we next analyzed each week of data for all 1,179 reference names. In aggregate, there should be 181 x 1,179 = 213,399 "reference name-weeks" of data reported, but there was no data reported on 57,399 occasions because there were no trades in that week for that reference name. Dividing these 57,399 observations by 1,179 reference names shows that, on average over the 181 week period, there were 49 weeks for each reference name in which there were zero CDS trades. The daily average non-dealer trade volumes for the 156,000 non-zero weekly observations have the following distribution:
Again, this analysis allows us to draw some more surprising conclusions about all weekly trading in single name CDS for all 1,179 reference names, and a total of 213,399 potential observations:
- 26.9% of the 213,399 potential observations showed zero trading volume
- Of the 156,000 non-zero observations, we found
- 99% of the observations showed less than 9.63 non-dealer trades per day
- 95% of the observations showed less than 4.84 non-dealer trades per day
- 75% of the observations showed less than 1.65 non-dealer trades per day
- The median number of trades per day, excluding the "no trade" observations, was 0.66 contracts
After reviewing the non-dealer trading volume reference name by reference name, we repeat the warning from our January 4, 2012 analysis: a sophisticated observer should assume that both traded CDS spreads and quoted spreads are highly likely to have been affected by collusion. Indeed, the first lawsuits in this regard were filed in 2013. Any other assumption could be hazardous to your wallet.
Additional disclosure: Kamakura Corporation has business relationships with a number of organizations mentioned in the article.