Summary
CDS have created problems for some time now. The proposal to regulate CDS over the counter sales will in my opinion create more problems than it will solve. This is especially in the context of the triple regulation suggested - SEC, CFTC and a dispute regulatory mechanism for the turf between the two bodies. In this analysis I look at the accounting and economic problems that this will create.
Analysis
1. Credit derivative swaps may be in for a major overhaul including banning the trading of some kinds of CDS. This is however like locking the door after the horse has bolted and run away.
2. Accounting treatment of derivatives is spread over several accounting standards. Recent economic events have also brought out the problems in the measurement and presentation of fair value of CDS and other derivatives in financial statements.
3. The proposal to have a triple regulatory structure for these instruments will only complicate the situation. The effect will be that a major source of finance will dry up and other unknown complicated instruments will take their place.
4. In my opinion a proper refined accounting presentation so that users/purchasers of these instruments know the true fair value of these instruments would serve the purpose better.
5. From the economic perspective one would see a worsening of the corporate cash flow.
6. I would say watch the legislative action on CDS with bated breath because this is going to impact :
- Financial statement presentation,
- Valuation of CDS
- Availability of finance to the corporate sector
Nitish Grover consults with leading institutions through GLG
Analyses are solely the work of the authors and have not been edited or endorsed by GLG.
