Credit Derivatives and Structured Credit: A Guide for Investors

Conclusion

In 1998, we concluded the first edition of this work by highlighting the most crucial challenge faced by the credit derivatives market at the time: the creation of liquidity. How much ground has been covered over the past seven years!

Several factors have contributed to the increase in liquidity on the CDS market, and they have ensured that CDSs have become mainstream capital market instruments. These factors include:

• Standardization of legal contracts.
• Clarification of the regulations (for banks).
• Advances in information technology, risk management processes and trading infrastructures.
• Emergence of market standards for structuring, modeling and pricing.

The unprecedented default wave of 2001–2002 also challenged the resilience of the credit derivatives market and proved its solidity. This ‘baptism of fire’ gave credit derivatives a central role in the capital markets, which will no doubt grow in the years to come. Their strong growth has in turn broadened the range of applications and number of users, and further fuelled product innovation.

It is very likely that the credit derivatives market will grow in an already-established pattern, like that followed by interest rate, currency and equity derivatives: pioneered by banks, often for their own needs, these other forms of derivatives were then offered to a sophisticated customer base of institutional investors, before being extended to the ‘mass market segments’ of corporates, retail and private banking investors. ...