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Exchange-Traded Solvency Derivatives
In the last ten years, the credit derivatives market has grown from its infancy to approximately $26 trillion of notional value according to the International Swaps and Derivatives Association, Inc. ('ISDA'). The most highly utilized type of credit derivative, the credit default swap, is used by investors to bet on a company's creditworthiness or hedge a position in a fashion that protects against the company's failure to make a payment or satisfy other terms.
To date, credit default swaps have been issued only in private transactions and traded solely in the over-the-counter market ('OTC') by large, sophisticated investors. Thus, while the proliferation of credit default swaps has had an impact upon distressed companies, the lack of a standardized, exchange-traded credit default swap has limited the scope and magnitude of this impact.
Recently, the Chicago Mercantile Exchange ('CME') obtained approval from the Commodity Futures Trading Commission ('CFTC') to offer the first ever standardized, exchange-traded, centrally cleared and guaranteed product available to the credit derivatives market. These instruments, called credit event contracts ('CECs'), are intended to provide a transparent and liquid means of acquiring protection against the filing of a bankruptcy case by or against a single company (the 'Reference Entity'). Trading through a central counterparty such as the CME should remove many of the risks, difficulties and expenses associated with trading credit default swaps. Thus, the availability of CECs is likely to foster further expansion of the credit derivatives market and will undoubtedly have a significant impact upon future corporate restructurings.
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