Trading in credit-default swaps has tumbled 40% to 60% from three years ago as banks prepare for new regulation of derivatives.
The declines estimated by executives at four of the biggest dealers of swaps means lower profits at firms that used to get as much as two-thirds of credit-market trading revenue from the derivatives. Moody's Investors Service says pending rules may translate into job cuts of as much as 50% in groups that trade the contracts.
Investors are avoiding strategies that contributed to $1.82 trillion in writedowns and losses during the financial crisis. The net amount of credit swaps outstanding globally has fallen 20% from October 2008, the earliest figures disclosed by the Depository Trust and Clearing Corp. in New York.
"This was a major profit center for a lot of banks," said Hal Scott, a Harvard Law School professor who also is director of the Committee on Capital Markets Regulation, a group of academics and business executives that in May 2009 called for measures to reduce the risks derivatives pose. "It's part of a bigger picture of reduced financial activity due to uncertainty and regulatory reform."
The contracts, in which a seller of protection is paid an annual premium for agreeing to cover the buyer's losses should the underlying borrower default, ballooned to more than $62 trillion at the peak in 2007 on a gross notional amount from $632 billion in 2001.
The five biggest dealers — JPMorgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley, Citigroup Inc. and Bank of America Corp. — bought a net $430 billion of credit protection at Sept. 30, down 38% from $689.9 billion in March 2009, filings with the Federal Reserve Bank of New York show. Average daily trading in U.S. corporate bonds fell 12% the past six months compared with a year earlier, according to the Securities Industry and Financial Markets Association.
The Dodd-Frank financial overhaul will require most trades to go through clearing houses that are capitalized by the banks and demand uniform amounts of collateral backing the trades.
To make up for lost revenue, banks are considering products they rebuffed three years ago: Futures contracts that would be tied to benchmark credit indexes and traded on exchanges such as ones from CME Group Inc.