The analysis of CDS market and their role in financial market

The credit default swap market grows too fast in recent years,and the depository trust and clearing corporation(DTCC) estimates that large exposures to credit default swaps can create substantial systemic risk.Because of this potential risk, some people argued that credit default swaps should be clearred through central clearing counterparties, or clearinghouses, the author analyze the market for credit default swap and make specific recommendation, about appropriate roles for clearinghouses and about how they should be organized.

First, the authors think that the well-functioning clearinghouses can reduce systemic risk, so they encourage the financial institutions to use them to clear credit default swap and other derivatives contracts.Bank and other regulated financial institutions should raise the capital requirements for contracts that are not cleared through a recognized clearinghouse to avoid any potential risks.

About this point of view,I don’t agree with the authors, I think the state-owned bank shouldn’t use the credit default swap, because it is just transferring the banks’ risk to any other financial institutions, and compare with the state-owned banks, the financial institutions don’t have the strongly control and manage of the financial market when the recession happens, if the banks transfer their risk to other financial institutions, which will cause higher systemic risk.

Second, they advise to reduce the number of the clearinghouses rather than magnify systemic risk, and they also think that all the clearing houses should be required to have strong operational controls, appropriate collateral requirements and sufficient capital.

I am kindof agree with them on this point, Although the more clearinghouses will give us more option and lower the clearing fee, it will also create more risks for the systemic, because the financial institutions will continuely transfer their risk to others, this is a vicious spiral. The more clearinghouses we have, the more risk they will create.

Third, the proliferation of clearinghouses would eliminate opportunities in order to reduce counterparty risk, while this will create unnecessary risk, so the regulators and the lawmakers should not intentionally or unintentionally promote the proliferation of redundant or specialized clearinghouses.

This recommendation is similar to the second one, both means to reduce the number of the clearinghouses and hinder their proliferation to make sure the stable of the financial market. Because a well-functional clearing house will fail, if this happens, all their proliferation will be affected, this will cause significant consequences. So we should control the growing of their proliferation on one hand and improve the clearinghouses’ own financial power on the other hand.

Fourth, they suggest that the regulators should promote greater transparency in the CDS market for the more liquid and standardized index and single-name contracts and should give consideration to the introduction of a trade reporting system for these contract similar to the trace system for corporate and municipal bond trades in the united states.

For this point of view, the CDS market need greater transparency to make sure all the trade are real and to help invent men to make the correct decision, and this is also a good way to test their financial power. In recent years, there has been a lot of Paper Company, so improving the transparency will help to eliminate these kinds of institutions. While for the consideration of trade reporting system is not acceptable, because the clearing do not need the exchange trading. They shouldn’t participate in the other trading system,’

To conclude, in order to reduce the systemic risk, the regulator and lawmakers should make some laws to make the clearinghouse more well-functional, and reduce their proliferation and also improve the transparency of the CDS market. The most important is to strengthen the control of these clearinghouses.