Credit derivatives are a subspecies of derivatives and tradable financial instruments , the loans , loans , bonds or comparable assets as underlying (English underlying have) the content and measure inherent in potential default risk in the secured party secure and the guarantor increase. There is also the purely speculative variant of the naked credit derivatives without an underlying asset.
Credit derivatives are a relatively new financial instrument. It was developed in 1991 by the investment bank Bankers Trust . In 1996, the international market for credit derivatives had for the first time reached a volume threshold that was of interest to all market participants. A survey by the Deutsche Bundesbank among the 10 most active German banks on the credit derivatives market showed in 2004 that these institutions acted as collateral providers with around 220 billion euros and 210 billion euros as collateral takers in “single name CDS”. From a regulatory point of view, the Deutsche Bundesbank had determined that the CDS markets “have a price leadership due to the faster processing of new market information compared to the bond markets and that they are clearly ahead of the credit rating downgrades by rating agencies ”. It was not until the beginning of the Asian crisis in August 1997 that global interest in risk transfer in the form of credit derivatives increased, and after the Russian crisis in August 1998, the market share finally increased sharply.
In the case of credit derivatives, there is the buyer ( protection buyer ), the seller ( protection seller ) and the underlying transaction to be hedged ( underlying ), i.e. the credit risk in a loan, credit or bond with respect to the reference debtor . The creditor of this credit risk can have an interest in hedging his credit risk as the buyer of protection by means of a credit derivative. In doing so, he retains his credit risk; it is hedged by the credit derivative. The original credit relationship between the protection buyer and the reference debtor is therefore neither changed nor re-established. Credit risk and credit derivative therefore exist side by side with the protection buyer. This is different with the collateral provider. It only acts as a contractual partner in the credit derivative without having to be related to the reference debtor. Only in his function as collateral seller does he acquire a credit and payment risk of having to pay the collateral buyer in the event of a credit event.
According to the legal definition of (3) No. 4 WpHG, credit derivatives are “all fixed or option transactions that are structured as purchases, swaps or otherwise, which are to be fulfilled with a time delay and which serve to transfer credit risks”. In Abs. 11 No. 3 set. 4 KWG is a coincident with the WpHG legal definition.
Credit default swaps , total return swaps and credit linked notes are credit derivatives according to Art. 204 No. 1 Capital Adequacy Ordinance (CRR) that are recognized by the regulatory authorities as collateral for the protection buyer if one of the credit events defined in Art. 216 No. 1 CRR occurs and the determination of the event is not the sole responsibility of the collateral provider (Art. 216 No. 1e CRR). In addition to the final list , the Capital Adequacy Ordinance particularly depends on the fact that it is not the responsibility of the collateral provider to determine that such an event is deemed to have occurred. If the ISDA framework agreements ( ISDA Master Agreements ) are used, this is ensured, since the determination of a credit event is withdrawn from the contracting parties and is the sole responsibility of the ISDA Determinations Committee . The following credit events are specifically listed in Art. 216 No. 1a CRR:
- The failure to provide the payments due to the force at the time of the failure conditions of the underlying liability, wherein the extension of the underlying obligation corresponds to or below
- Bankruptcy, bankruptcy or the inability of the debtor to service his debts or his written admission that he is generally no longer able to pay debts that are due ( moratorium ), as well as similar events
- The restructuring of the underlying liability, combined with debt relief or deferral of the loan amount, interest or fees that results in a loss on the part of the lender.
If these prerequisites are met, the protection buyer may count his credit risk as secured with a guarantee , with the result that a lower level of capital adequacy is required. Credit derivatives are regarded as collateral for the protection buyer and - because they are equivalent to the guarantee - are part of the personal collateral . Credit derivatives are a suitable instrument for risk management because, in return for payment of a premium, an existing credit risk is borne by the protection seller.
Forms of Credit Risk
In risk analysis , risks are usually divided into two main groups
- Market price risks ( exchange rate risk for currencies , interest rates , stocks ) and
- Counterparty risks .
The credit risks are pure credit risk and creditworthiness risks ( spread risks ) distinguished. In the case of default risks, a credit event that has not been provided is always the triggering credit event, while in the case of creditworthiness risks, an expansion of the risk premium to the risk-free interest rate and thus the decline in the present value of the investment serves as the basis. In this respect, credit derivatives can also be divided into default-related and rating-related credit derivatives.
A general distinction is made between event-related and market price-related credit derivatives.
- In the case of event-related credit derivatives, the protection seller makes payments to the protection buyer if a credit event defined for the underlying reference entity occurs. Since the obligation to pay from the credit derivative depends directly on the occurrence of the credit event, a clear definition and independent verifiability of this event are of crucial importance.
- In the case of market price- related credit derivatives, the payments between the parties involved are based on the price development of a specific financial instrument or its price development relative to the relevant overall market. A deterioration in the creditworthiness of a reference debtor has a negative effect on the price development of a financial instrument it issues . In the case of market price related credit derivatives, payments are made by the buyer to the seller of the credit derivative and vice versa in the event of a positive price development.
Due to the innovative strength of the credit system, especially in the derivatives area, there are now several types of credit derivatives.
Credit Default Swap
The credit default swap (CDS) or credit default swap is similar in its mode of action to a guarantee. There are two variants depending on whether the acquisition of an underlying asset (physical settlement ) or cash settlement has been agreed for the occurrence of the credit event . If physical fulfillment has been agreed, the protection buyer must actually be in possession of the underlying asset in order to be able to deliver it to the protection seller in the event of a credit event. In addition to the classic credit default swap, there is also the uncovered CDS ( naked ), which does not have an underlying asset, serves purely speculative purposes and does not aim to hedge a credit risk. Uncovered CDS on state risks were generally banned in the EU from November 2012 in order to prevent speculation about the threat of national bankruptcy . Only those who hold bonds and credit holdings with states can acquire CDS and thus hedge their risk of default. The uncovered CDS vis-à-vis non-governmental reference borrowers remains permitted.
Credit default option
A credit default option or credit default option is an option to buy or sell a credit default swap.
Credit Linked Note
Credit Spread Option
A credit spread option is an option on the interest rate difference between two base values, at least one of which contains or represents a credit spread for a credit risk . Credit spread options are possible in different variants. Their underlying asset can be both a difference in return and a price difference, they can relate to interest and dividend stocks, and they can have a wide variety of payout profiles and conditions.
Credit Spread Forward
A credit spread forward is a forward transaction based on the difference in interest rates between two underlying assets, at least one of which contains or represents a credit spread for a credit risk . Also credit spread forwards are possible in various forms. Similar to the credit spread option , its underlying asset can be a price or yield spread, whereby it can refer to interest or dividend stocks.
Total return swap
With a total return swap , the total return on the underlying asset is swapped for another return. It is not a pure credit derivative: From a risk perspective, not only credit risks but also market risks are swapped.
In addition to the types of credit derivatives mentioned, there are also complex hybrid products:
- Synthetic asset-backed securities
- Synthetic Mortgage Backed Securities
- Synthetic Collateralized Debt Obligation
Since 1998, the International Swaps and Derivatives Association (ISDA) has provided standard documentation for credit default swaps , which enables the parties involved to choose from the specified alternatives. The ISDA master agreements make negotiations easier for the contracting parties, as basic questions no longer have to be clarified.
Credit derivatives are bilaterally binding contracts whose mutual claims are deemed not to have been fully met on the balance sheet date . They therefore belong to the category of pending transactions . According to (1) sentence 2 nos. 3 and 4 KWG, these are part of the off-balance sheet business of the credit institutions and are therefore to be noted “under the balance sheet” (“bottom line”). For accounting purposes, derivatives may not be offset against each other, even if netting agreements exist with the contracting party . The set-off provided here is linked to the occurrence of certain events and does not comply with the rule IAS 32.42, which allows offsetting if there is a current and enforceable right to offsetting. Therefore, the general offsetting prohibition according to IAS 1.32 must be observed. According to IAS 39 and IAS 37, credit derivatives are generally to be accounted for as derivative financial instruments. In addition, according to German law, the offsetting prohibition in accordance with Section 246 (2) of the German Commercial Code (HGB) applies, so that the “bottom line” reported volume reflects the gross proportions.
- Bundesbank Monthly Report April 2004 / Instruments for credit risk transfer
- Matthias Mock, Marika Sauckel: Functionality and importance of credit derivatives. (PDF; 1.9 MB) Scientific Services of the German Bundestag, WD 4-3000-159 / 10. July 1, 2010.
- Sybille Gerold: Credit derivatives in practice - possible uses in companies and insurance companies . 2003, p. 14–15 ( schweimayer.de [PDF; 1.5 MB ; accessed on December 8, 2018]).
- British Bankers' Association, Credit Derivatives Report 2006 , p. 4. “Single-name CDS” thus dominated the entire credit derivatives market in 2006 with a - decreasing - share of 32.9%.
- Monthly Report Deutsche Bundesbank, April 2004, “Instruments for Credit Risk Transfer: Use by German Banks and Aspects of Financial Stability”, p. 27 ff.
- Monthly Report Deutsche Bundesbank, December 2004, “Credit Default Swaps - Functions, Significance and Information Content”, p. 43 ff.
- Guarantee and credit derivative are equated in Art. 399 No. 1 CRR
- Sebastian Oberhäuser, Risk Management with Credit Derivatives , 2008, p. 3.
- Sebastian Oberhäuser, Risk Management with Credit Derivatives , 2008, p. 4.
- EU wants to stop financial betting on bankruptcies , Der Spiegel online from October 19, 2010
- Sebastian Oberhäuser, Risk Management with Credit Derivatives , 2008, p. 6.
- Michael Luschhüter / Andreas Striegel, International Accounting, IFRS Commentary , 2011, p. 843.