Isda CEO takes on CDS 'misconceptions' and calls Lehman settlement a success

Isda chief executive officer Robert Pickel has commented on the cash settlement of credit default swap trades on Lehman Brothers today and on misperceptions about the CDS industry. Based on industry estimates, a total of $6-8 billion is expected to have changed hands by close of business.

Pickel emphasised that the Lehman default and settlement have not created the financial disruption that critics of the CDS business have claimed.

First, because the number of CDS trades outstanding on Lehman includes a significant number of transactions that offset each other, settlement payments are only a fraction – about 1% to 2% – of the approximately $400 billion notional of CDS trades referencing Lehman, he said.

Second, because firms are required to mark their positions to market and to post collateral, any additional exposure arising from the cash settlement is incrementally minimal. And third, despite the failure of this major dealer institution – as well as several other large counterparties – the CDS business continues to function effectively, said Pickel. He noted that CDS contracts have been consistently more liquid than their cash market equivalents.

In addition, Pickel pointed out some fundamental misperceptions about the nature of CDS. The biggest misperception facing the CDS business in general is its role in today’s financial crisis, while the root cause of problems of the financial sector is too many bad mortgage loans, he said. Although many of the loans were structured into mortgage backed securities (MBS) or were repackaged as collateralised debt obligations (CDOs) and sold to investors around the globe, no individual product or instrument was at fault; the economic fundamentals of those underlying exposures were simply not sustainable.