| Credit Default Swaps Essay
Credit Default Swap (CDS) market developed in 2007 has gone under several transitions over the years to increase the efficiency and the transparency of the financial system. During its initial stages, the system privately operated in the United States without proper negotiations, hence lacking efficiency and transparency. However, in 2009, great changes occurred in the system, and there was an introduction of the Small Bang and the Big Bang protocols. Introduction and the implementation of the CDS trading conventions also occurred during this period. This assisted in the achievement of a one-day trade matching as well as the elimination of any offsetting trade. Moreover, the changes assisted in the process of centralized clearance.
The financial crisis revealed many weaknesses of the CDS market system. It made financial institutions propose its changes. The main objectives of these changes were to enable the infrastructure of the market system. The Big Bang Protocol was introduced in the United States. This protocol helps to identify whether and at what time any credit transactions occur. This is of great importance to the country since fewer errors take place in credit transactions in terms of time and approval. The change also helps to determine whether there was a failure to hold any auction in order to solve the credit derivatives. It is especially significant in the United States in case the management of a company requires making an approval of any auctions in the market. The Big Bang Protocol in the CDS market also assists to recover the list of all the deliverable obligations of any relevant reference firm or entity.
The Big Bang Protocol helps in determining when and whether there is an occurrence of a succession event. It also helps to identify various successors or any substitute reference obligations. In case of a crisis or disagreements in any credit event in the CDS market, the Big Bang Protocol settles the disputes with the aim to determine the real successors of the credit. This helps in the transformation of the United States marketing systems since the business people do not face the risk of losing finances out of credits. The system helps to solve the issues of all the contractual interpretation that are relevant to credit derivative markets as a whole. For this purpose, there was an establishment of a determination committee that rules out whether a credit transaction occurred.
The introduction of the Small Bang Protocol in the CDS markets assists in settling payments that are included in the CDS contracts in case a distressed organization is required to restructure its liabilities. Due to the current problems in the administration of auctions for a restructuring transaction in any situation, the Small Bang Protocol plays a big role to determine whether to do an auction for every maturity bucket. The protocol enables the committee to decide the deliverable obligations for every maturity bucket as well as the transactions that involve the bucket. In this case, determination of the auctions for any restructuring event becomes difficult in the United States. The effect of the Small Bang Protocol as a change in the CDS markets is to avoid performing an auction on the illiquid credits and to prevent operating any unnecessary auctions. Not all the deliverable obligations show variations between two or even more buckets (Greatrex 2008). There is also the the movement option that has the intent to ensure that all the parties are about to make settlements through the auction despite its cancellation for a particular bucket. This suggests that the CDS market change in the US after the financial crisis through the Small Bang Protocol has been a player for great improvements made in settling debts through auctions.
The availability of several sources of agreement based on the end-of-day and the intraday pricing of products and services improves efficiency in the process of identifying the best of the present market prices (Greatrex 2008). This facilitates in making independent valuation of any portfolios and improved awareness about a products or services price behavior. Therefore, the completion of any available trades as well as the replacement with another smaller number of trades bearing the same risk characteristics effectively reduces the gross notional amount available without affecting the net or risk status. It brings a smaller regulatory capital requirement.
In conclusion, the changes developed in the CDS market after the financial crisis have had great improvements in the United States economy throughout the years. Apparently, this country succeeds in conducting transactions without fear of offering credits or performing auctions together with other benefits. The recent changes in the CDS market followed after the global financial crisis that saw the country make huge losses. After this crisis, the CDS market grew in a significant way reaching a high point in terms of the notional profits that were outstanding of over 62 trillion US dollars in the year 2007.
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