- REUTERS/Lucas Jackson
LONDON – One of the financial products blamed for worsening the 2008 financial crisis is back on the market.
Credit default swaps have been growing in popularity since 2015, as investors turn to riskier products in the pursuit of higher returns.
Low volatility in credit markets and high prices for corporate debt have encouraged the growth in activity, with the value of trades for this year up to $30 billion, compared with $15 billion in 2016 and $10 billion in 2015, according to the Financial Times.
When asked about the risk of a high number of defaults, a hedge fund trader told the paper, “I am terrified of it,” but said they did not think it would happen.
CDS contracts are designed to protect those who own corporate bonds from the risk of default. The seller takes on the risk of default from the buyer, in return for an upfront payment and periodic payments throughout the lifetime of the agreement.
If the issuer does not default, sellers can experience very high yields, higher than the return on most high-yield bonds. Investors are hoping to generate high returns at a time when credit markets are experiencing low fixed rate yields.
“Bespoke tranches” are bundles of CDS contracts, which are divided into “tranches” with varying levels of risk and return.
Since bespoke tranches are not graded by ratings agencies, they have a smaller investor base than some other financial products, and are most commonly bought by credit hedge funds. Recent well known investors include private equity firm Apollo and investment company Bridge Capital, while Citigroup is the largest bank counterparty for the trades, the Financial Times reported.