The over-the-counter CDS market acquires Russian standards

The Russian over-the-counter market is taking another step towards increasing transparency and reducing risks. In the near future, standards for “insurance against default”—CDS (credit default swap) contracts—will be approved, which will allow centralized settlements with these instruments in the Russian legal framework.

The Board of Directors of the National Association of Stock Market Participants (NAUFOR) approved the CDS standards. The standards (available to Kommersant) were developed jointly by NAUFOR, the Association of Russian Banks and the National Currency Association. One of these days they will be sent to the Central Bank for review and published on the NAUFOR website. From the moment of publication the standards will come into force. This means that, presumably by the end of the month, Russian market participants will be able to structure CDS in accordance with standards, which will make it possible to regulate transactions with these derivatives in the Russian legal framework.

A CDS, or credit default swap, is a derivative financial instrument that is a contract on a debt security with the risk of default on it. A CDS is issued by a company or bank for a premium and guarantees that a loan or bond issue will be repaid, if not by the issuer of the bond, then by the issuer of the CDS.

Russian banks still carry out transactions with CDS on the basis of their own forms, but, according to market participants, mainly under English law. “It is difficult to estimate the volume of transactions concluded, since they are carried out on the over-the-counter market. However, CDS, including those for the most liquid Russian bonds, are quite often used by professional participants, for example, as a component of structured products,” says managing partner of FinEx ETF Oleg Yankelev.

In the West, CDS appeared in the mid-1990s. As is usually the case with derivative financial instruments, they quickly turned from purely hedging to speculative. According to the International Swaps and Derivatives Association, the global CDS market reached $62.2 trillion by 2007. After the 2008 crisis, the market shrank to $38 trillion. The CDS market contributed to the development of the global financial crisis. When mass defaults on highly rated bonds began in the market, not all CDS issuers were able to pay their obligations. In 2009, the financial authorities of the United States and Europe decided to transfer the over-the-counter market, and in particular CDS, to settlements through a guaranteeing third party of transactions—central counterparties—to reduce risks.

Standardization of CDS is a necessary condition for carrying out settlements on them through a central counterparty, as well as for offsetting the claims and obligations of the parties to a transaction in the event of bankruptcy of one of them (liquidation netting). “If the parties operate CDS on the basis of standard SRO documentation, then the obligations under these derivatives in the event of bankruptcy of one of the parties will not be included in the total bankruptcy estate, that is, they will not be frozen,” explains NAUFOR Chairman Alexey Timofeev.

In theory, standard CDS may be interesting, in particular due to debt market conditions. “This instrument will be in demand due to the growing risk of default on bonds,” Mr. Timofeev is confident. “This tool is necessary for any developed financial market. When market conditions stabilize, it will make it possible to more effectively manage credit risks,” says Igor Golutvin, co-head of the structural transactions department at VTB Capital (actively working with CDS).

However, according to Mr. Yankelev, banks and companies will most likely continue to enter into transactions under foreign law whenever possible. “Russia has weak law enforcement practice in relation to derivatives. There is a risk that in the event of bankruptcy of one of the parties, counterparties will seek to avoid fulfilling their part of the transaction,” he explains.

Lyubov Tsareva

Rules for insurance against default