EMERGING MARKETS: ‘Naked’ CDS worry LatAm policymakers

The controversial instruments were partly blamed for Greece’s debt problems

Latin American officials are looking at ‘naked’ credit default swaps (CDS) – instruments allowing investors to insure against a country’s default without actually owning the country’s bonds – with concern, Emerging Markets can reveal.

The instruments, which have been compared by market experts to buying insurance on a neighbour’s house and were partly blamed for the sharp spike in bond yields that triggered the eurozone’s debt crisis, were banned in the European Union last year.

Euro-MP Sven Giegold, a member of the German Green party, called for a ban on ‘naked’ CDS in emerging markets’ debt too, after a non-scientific online poll that he organized nominated them the most dangerous financial products around.

Although the market in those instruments is not very developed in Latin America, the use of the CDS market “has certainly been a contentious issue,” Alejandro Diaz de Leon, deputy undersecretary for public debt in Mexico, said.But he added that Latin American regulators must look first at how the rest of the world deals with the issue. “We have to see how regulations around the world evolve on the use of credit default swaps,” he told Emerging Markets.“As far as we are concerned, they are a useful instrument for investors and the market allows flexibility for them in hedging positions,” Diaz de Leon added.

Julio Velarde, president of the Central Bank of Peru, said CDS could be useful instruments, provided they were used for their real purpose: that of hedging against default on bonds that investors hold. “Concerns are mostly surrounding ‘naked’ CDS,” Velarde said.

He noted that monoline credit operators, which used to offer insurance against default, “have disappeared completely” and CDS now fill that void. “They are a way to protect yourself without selling the underlying paper and so it makes the overall market more efficient,” Velarde said.

But the way the instruments are traded could do with some improvements, in his opinion. “It would be better to have a centralized market and not rely so much on the over-the-counter market for trading this paper. It’s a way of getting protection and is better than just selling the underlying bonds, which adds volatility to the market”.

Another problem that Velarde sees with the instruments is the definition that they give to a default event. “Sometimes the CDS contract makes non-payment on the bonds as non-binding for CDS. That is a bad idea as then you don’t need the CDS market at all.” But overall, he said, “I would say the market has more benefits than dangers.”

Credit default swaps were very much in the public eye when Greek debt was restructured last year but discussions surrounding what exactly constituted default so as to trigger payments for CDS holders have died down since.“There has to be a process of revisiting the topic,” Azucena Arbeleche, director of public credit in Uruguay, said. Because Uruguay does not have a liquid credit default market, it looks at the CDSs of neighbouring countries, such as Brazil, for pricing, she added.


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I've been researching and writing on Brazilian financial markets, industry and economy since 2006 for a wide range of specialist media, consultancies and investors. Before that I spent over 10 years in London and New York writing for and editing magazines and journals dedicated to finance, investment and economics in developing markets, mostly for the Euromoney Institutional Investor group and Thomson Financial. Areas of coverage Below are samples of areas that I cover and some of the common themes that I investigate. Capital markets BM&FBovespa markets *capital raising trends: via equities (IPOs and secondary issuance), debt and loans *the asset management industry: legislation and coverage of the key hedge, pension and investment funds * corporate governance: how the regulator is seeking to strengthen best practice and limitations * debt markets: the nascent corporate markets, attempts to boost liquidity and new insturments. * private equity market: why this market has been so successful, who’s involved. *electronic, high frequency trading and alternative trading platforms: what does the future hold? Banking *credit: the growth of consumer and business credit and competition between banks and models *Public versus private: the role and market share of public and private sector banks and the politicization of the industry * internationalization: which Brazilian banks are expanding overseas and where * investment banking: the growth of the domestic market and who’s winning which mandates *regional banks and development banks: what role they play in the industry and how they compete Mining *licensing: the complex process of obtaining environmental, water, land and operating licenses at a state and federal level. * capacity: the feasibility and sustainability of capacity increases * financing: how miners are raising finance in Brazil and abroad *competition: the interplay Vale, MMX and junior miners *logistics: rail, road and port connections Oil and gas: the fund raising issues related to the massive of pre-salt (link) Multilatinas: Who are they and how and where they are expanding Meatpacking: Are debt burdens sustainable, what are the different business models for areas such as branding and distrbution Agriculture: How are farms consolidating, what are environmental risks, how can foreign investors be involved. IT and software: Can Brazil take on India and build a viable long-term IT industry? For more information on clients and work, please see the media and consultancy sections.
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